When Emerging Markets Collapse

As the saying goes, "all good things must come to an end." We've seen it happen with the dot-com bubble and more recently with the housing bubble. One day in the future, the emerging market buzz will eventually come to an end, as well. However, could it happen to China, Brazil, and India sooner rather than later? More experts are starting to think so, and if they're correct, it could have profound effects on your international investments.

The current status
Emerging-market economies have been on fire this year as they continue to overtake developed countries in terms of economic output. China recently over took Japan as the world's second-largest economy, but that hasn't slowed it down a bit. In the third quarter to date, the Chinese economy has grown at a 9.6% annualized rate. That is no doubt impressive, but so is India's 9% and Brazil's 8.8%. Judging by this data, everything looks peachy for sustained growth in these regions.

Changing dynamics
Unfortunately, the good times cannot continue to roll forever. Eventually, emerging-market economies will hit some speed bumps. How and when this will occur is anyone's guess. However, there are warning signs that those speed bumps are closer than they appear.

As the debate in the U.S. focuses on inflation versus deflation, there is no question that inflation rules in developing countries. Brazil is looking at a 5.7% inflation rate, while India is staring at rates above 8%. Again, not to be outdone, recent data in China suggests that inflation is more than 12% on an annualized basis. Increasing food prices have been a particularly difficult problem, as it's causing hardships on the less affluent in these countries. It appears that in these economies, high growth rates are in part causing high rates of inflation.

You may be asking yourself, why don't these countries take action and fight off inflation? Well, they have certainly been trying. The Chinese central bank has attempted to do this on several occasions this year through restrictions on bank lending. Within the past few weeks, Brazil has undertaken similar measures as China. Meanwhile, India is still battling the inflation monster despite its central bank raising interest rates six times this year alone. Despite these attempts, these measures have yet to cease the surge in prices.

As long as inflation remains stubbornly high, there is an increasing likelihood that the economies of these countries may come to a screeching halt. If inflation remains unchecked, it could spiral out of control and harm growth. On the other hand, the leadership of China, India, and Brazil must be careful. If measures taken to control rising prices are too strong, they may eventually stunt the current expansion. It's a delicate balancing act -- inflation versus growth -- with a lot riding on the outcome.

Investing ramifications
Now that you are full of knowledge on issues in emerging-market economies, what should you do with your portfolio?

You're probably tired of hearing it, but make sure your portfolio is diversified. Ensure that you aren't overexposed to emerging markets. Sure, the returns are awfully tempting, but you can't afford to have too many of your eggs in one basket. Below are some suggestions for adding some variety to your holdings.

Consider broad international ETFs that allocate your money to more than just emerging-market countries. For example, the iShares MSCI All Country World Index Fund and the Vanguard Total World Stock ETF (NYSE: VT  ) both track a broad range of stocks across the globe, including those in the U. S. and developing countries.

Not looking for positions in the U.S.? Well, there are plenty of ETFs for that, too. Some good options include the WisdomTree World ex-U.S. Growth Index, which finds growing companies, and the Guggenheim International Multi-Asset Income ETF, which specializes in investment income from international assets. These ETFs provide loads of diversity for you to consider.

As for stock picks, there are lots of alternatives depending on your strategy. There are numerous companies with healthy but not excessive exposure to emerging markets. Multinational businesses like Nike (NYSE: NKE  ) , Anheuser-Busch InBev (NYSE: BUD  ) , Boeing (NYSE: BA  ) , and Coca-Cola (NYSE: KO  ) are just a few examples.

You may also want to consider commodity plays if you believe inflation will continue to persist. Companies like BHP Billiton (NYSE: BHP  ) and Schlumberger (NYSE: SLB  ) bring valuable resources to emerging markets and stand to benefit immensely if these conditions persevere.

You should not be afraid to invest in emerging markets, but don't be smitten with their outsized returns. With an assorted selection of international stocks, you can be more confident that the outcome of the inflation battle in China, India, and Brazil won't lead to disastrous returns for your portfolio.

More on Emerging-Market Economies:

Fool contributor Gerard Torres has no beneficial interest in any of the companies/positions mentioned in this article. Coca-Cola is a Motley Fool Inside Value selection. Nike is a Motley Fool Stock Advisor recommendation. Coca-Cola is a Motley Fool Global Gains pick. Coca-Cola is a Motley Fool Income Investor recommendation. The Fool owns shares of Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On December 18, 2010, at 10:55 AM, jan1971 wrote:

    If you have the choice between investing in a fast-growing economy with still very low wages in comparison with the US, very low consumer debt-levels, a young population and relatively high interest rates that might come down further or investing in low-yielding bonds or stocks of a country with a 45% gap in its federal budget, a 40% gap in its trade balance, many almost bankrupt states, cities and counties, tens of percents of its households in deep financial trouble and a greying popülation, what would be your logical choice neglecting fear for the unknown then?

  • Report this Comment On December 18, 2010, at 12:19 PM, MKArch wrote:

    If you believe Jim Chanos is right and I think he is China probably has a bigger problem than inflation brewing right now. He makes a pretty compelling case they have an epic construction bubble blowing up right now that's going to bring their economy back to earth in a hurry when it pops.

    He thinks this will hurt the U.S. as well but other than panicked markets translating to the broader economy for a while I don't think so. We don't sell much to China and they'll keep manufacturing cheap stuff for us however commodity prices are likely to come back to earth with China which will ultimately be good for the U.S. economy.

    I'm long the U.S. in my personal portfolio and built a long U.S. CAPS portfolio over the last year and a half as well.

  • Report this Comment On December 20, 2010, at 8:43 PM, ynotc wrote:

    If China's currency is pegged to our currency and China's inflation rate is 12% why is our inflation rate below 2%? I know that the governments statistics no longer include gas prices and certain other goods but this just seems like more evidence that something is rotten in Denmark.

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