The Coming Emerging Markets Disaster

If you were looking for a formula to have an ultra-successful 2006, apparently the answer was one of the following:

  • Buy China (up 107%)
  • Buy India (up 49%)
  • Buy Russia (up 51%)

The thing is, you could list nearly any diversified emerging market and you'd have beaten the performance of nearly every developed market. In fact, the only one that failed to beat every emerged market in 2006 was Chile, which turned in gains of "only" 30%. But if you held some of the firms like China's American Oriental Bioengineering (NYSE: AOB  ) or Russia's Wimm-Bill-Dann (NYSE: WBD  ) , you won big.

In fact, if you take the stock charts of the main indices of Brazil, China, and Russia and lay them over one another, the similarity between them is striking. They have each gone up similar percentages in similar patterns, with deep correlation between them, and not only because each of these economies sells to the West. Each has risen nearly threefold, and, frighteningly, emerging market debt now trades close to that of developed markets.

These charts also bear a close resemblance to the Nasdaq circa 1999. Clearly, just like with the tech stocks, the hard landing is coming because we're no longer considering risk. Maybe the drop comes this year. After all, given the potential continued weakness of the U.S. dollar, emerging markets are no place to hide. 2006 was just like 1999. Therefore 2007 will be just like 2000, with some absolutely pulverizing losses. Right?

Of course, the short term is a different story
The answer is "maybe." The reality is that, unlike the Amazon.coms (Nasdaq: AMZN  ) , InfoSpaces (Nasdaq: INSP  ) , and CMGIs (Nasdaq: CMGI  ) of 1999, the emerging markets have been generating truckloads of profits. And lest we forget, these companies turned out to be Internet-age successes. The losers from 1999 turned out shareholder pain of the kind we'd soon like to forget.

Compare this to the emerging markets, and you can honestly say, "This time is different." Yes, stock multiples have expanded, but their earnings have surged as well. Emerging market stocks as a group don't trade at triple-digit P/Es like tech stocks did, when you could measure using earnings in the first place. Instead, a survey across emerging markets show some stocks that are quite cheap: Brazil's Petrobras (NYSE: PBR  ) has failed to keep up with a surging market, but doesn't even qualify as the cheapest stock in the country, which may fall to such opportunities as Tele Norte Leste and Sadia.

The problem is that when developed economies get the sniffles, emerging markets get full-blown influenza. This is why I say "maybe."

In May, the now-well-forgotten downdraft in the U.S. markets caused the Indian stock market to collapse. It recovered, of course, but not without scaring investors there to death. For some, literally so.

Unfamiliar territory? Try a guide
While I believe that there is a great probability that people pouring into emerging markets now will see some disappointment, there are values in many of these places, if you know where to look.

The opportunities and difficulties in overseas investing were the reason that The Motley Fool founded its Global Gains investing service. Each month we sift through thousands of companies overseas, in markets as diverse as Papua New Guinea and Switzerland. Most importantly, we're patient. If you'd like some help finding international stocks, click here to take a 30-day free trial to Global Gains. There's no obligation to subscribe, but our hope is that you'll stick around to discover with us what the world has to offer.

Global Gains advisor Bill Mann owns shares of American Oriental Bioengineering, but no other company mentioned. Amazon.com is a Motley Fool Stock Advisor recommendation. Sadia is a Hidden Gems pick. The Motley Fool has a disclosure policy.


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