The Scariest Investment You Can Buy Right Now

For years, investors have counted on emerging-market stocks to deliver consistent high-octane growth for their portfolios. Now, though, emerging markets are letting faithful investors down, and it's far from clear whether they'll bounce back or continue falling as the global economy starts to see new signs of stress.

What goes up ...
Throughout a lost decade for U.S. stocks, emerging markets seemed to defy financial gravity. Thanks to extremely strong economic growth rates in China, India, Brazil, and Russia throughout much of the past decade, emerging-market stocks vastly outperformed not only their U.S. counterparts but also stocks of other developed countries. Even as many large economies around the world suffered substantial contractions during the 2008-09 financial crisis, China and Brazil merely saw red-hot growth rates slow a bit.

But even boom times can't last forever. Emerging-market countries face a host of new challenges:

  • In China, efforts to try to ease the economy to a slower, more sustainable growth rate have become increasingly difficult. With some local real estate markets in Hong Kong and mainland China nearing bubble status, a disruption in housing could cause similar problems to what U.S. investors have seen domestically.
  • India is dealing with even more problems, including huge inflationary pressure. The nation's central bank raised interest rates last week for the 10th time in 15 months, yet the country's stock market is down 14% for the year and doesn't seem likely to turn around soon.
  • Brazil's economy is somewhat insulated from the troubles in Asia, although the nation is a key source of natural resources for China. Yet like its peers, the Latin American giant is fighting inflation and an overheating economy.
  • Russia's growth has been less dramatic than that of China and India. The country remains perilously dependent on its natural-resource riches, though, and is still fighting an image of being unfriendly to foreign business investment.

Stocks have followed suit. After a big rally last fall, the iShares FTSE China 25 Index (NYSE: FXI  ) is below late 2009 levels and has seen a loss for the year. The closed-end India Fund (NYSE: IFN  ) has seen a big loss since January, and the Brazilian iShares MSCI Brazil (NYSE: EWZ  ) is also struggling with the turn of economic events in its home country. Even the closed-end Templeton Russia & Eastern European Fund (NYSE: TRF  ) has not only seen losses but also trades near its biggest discount of the year.

How to make money in emerging markets
Perhaps the best lesson from recent events comes from the realm of Chinese small caps. It's easy for investors to think that when it comes to investing in an emerging stock market, which company you pick is more or less unimportant.

But nothing could be further from the truth. While smallish companies Yongye International (Nasdaq: YONG  ) and Harbin Electric (Nasdaq: HRBN  ) have been lightning rods for major allegations of questionable financial practices, other individual emerging-market stocks have thrived in the current environment. Similarly, relying on an ETF like Vanguard MSCI Emerging Markets (NYSE: VWO  ) gives you exposure not only to the best emerging-market stocks that you want in your portfolio but also to plenty of others that you may not want to own.

Don't be scared
For good or ill, the easy money in emerging markets has already been made. Hopefully, you got in on some of those profits early on.

Going forward, though, the key is to understand that as with any stock market, emerging markets will have some winners and some losers. Compared with a rising tide that lifts all ships, it's a little harder to pick through the bad stocks to focus solely on the good. In the end, though, your investing results will be a lot better for having gone to the extra effort.

Despite the danger of using exchange-traded funds to invest in emerging markets, there's one ETF that has what it takes to make our cut. Find out which one in our free special report, "3 ETFs Set to Soar During the Recovery."

Fool contributor Dan Caplinger got into international stocks early and has backed off a bit lately, but he still owns shares of Vanguard MSCI Emerging Markets. The Motley Fool owns shares of Vanguard MSCI Emerging Markets and Yongye International. Motley Fool newsletter services have recommended buying shares of Yongye International. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy works around the world for you.


Read/Post Comments (5) | Recommend This Article (3)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 22, 2011, at 1:37 AM, strelna wrote:

    With the greatest respect, I think you are dead wrong. I could not be more happy with my spread of 'emerging market' ETFs, all of which are long-term investments and all of which are showing a superb result. That is because I think 'emerging' is a misnomer. There are now growth markets and non-growth markets. I think it is better to be where the growth is, even if, in the short or even medium term, such growth is not correlated with stockmarket performance. It will be over time. I also feel more secure being indirectly in currencies which are not hopelessly indebted.

    The strategy is, as always, buy only when cheap and otherwise try not to look at them.

    I love your patriotic list of the problems they face (which are considerable)! But are you not missing out the, ahem, risks present in the USA where the economy resembles that of Greece. You may be confident that bondolders will continue to accept a yield under 3% on 10-year Treasuries but I am not (and using another ETF to bet against it).

    I am also confident that a range of 'emerging market' ETFs, constantly taking advantage of new introductions when they are cheap, will also beat self-selection over a realistic investment timescale, say 20 years. So far, so good.

    .

  • Report this Comment On June 22, 2011, at 5:25 AM, CSIHawaii wrote:

    When an English major blabs on about things they have heard but don't understand - you end up with something just like this article.

  • Report this Comment On June 22, 2011, at 7:41 AM, TMFGalagan wrote:

    @strelna -

    Thanks for your comments. I'd certainly agree with you that the time to buy emerging markets is when they're cheap. I just don't think the recent price drops have compensated for their huge gains over the years, and I suspect new ETF introductions are more likely to come when they're expensive rather than cheap.

    best,

    dan (TMF Galagan)

  • Report this Comment On June 22, 2011, at 3:33 PM, chadscards1274 wrote:

    The real challenge with emerging markets right now is the questions surrounding the realiability of the earnings and assets that investors use to value these stocks. When one small company is found guilty of making up their numbers it becomes guilt by association. If there is a way for confidence to come back there are some seriously screaming buys in international stocks. Specifically there are multiple Chinese stocks in all different industries that sell for P/E multiples of 1-7 times earnings based on next years projections. These are for companies that are expected to have 10%-25% growth rates. The problem is no one knows if 1. The earnings projections are being based on false current numbers.

    2. How do you gauge future growth not knowing if the current numbers are for real

    It's essentially like trying to figure out a stock's value without being able to use standard measures like P/E, PEG, etc. The only solution right now seems to be to stick to the larger more well known companies and hope that confidence can be restored over time with some of the smaller firms.

  • Report this Comment On June 23, 2011, at 4:46 PM, easyavenue wrote:

    MHenage-

    I don't think 'abstain and hope' are particularly good investment strategies.

    There's a lot (too much, really) info out there on Chinese small caps, on specific companies, to generalize. IMHO Picking one that uses a name auditor should minimize risk ala fraud and reverse merger. Solid due diligence wouldn't hurt, either.

    Using a dollar cost averaging approach would, I think, generate a nice return over the next decade or so.

    Again, this is just MHO.

    EA

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