5 Stocks for a Shifting World

The traditional divides separating North/South and developing/developed countries are blurring, as the distinctions between those economies narrow (and in some cases, reverse!). Those investors who equate "emerging markets" with "risk" are shutting themselves out of an enormous -- and growing -- set of investment opportunities.

Bad mental models
Here is a topical example of archaic mental models at work: European leaders are trying to bulldoze developing countries into accepting their candidate for head of the International Monetary Fund, French finance minister Christine Lagarde. This attitude is a relic of the feudal tradition, according to which the role is reserved for a European (often French).  While it will probably succeed this time, that approach is ill-suited to the realities of today's global economy.

Looking forward
Some forward-looking organizations are anticipating the shift in the balance of economic power that is already taking place. Giant bond fund manager PIMCO held its annual confab this month, the Secular Forum, in which the firm's professionals from around the world gather in Newport Beach, California to discuss what the next three to five years are going to look like for the global economy.

PIMCO's CEO, (Egyptian-born) Mohammed El-Erian, summed up some of the conclusions of the Forum. He remarked that, over the next few years:

Advanced economies will face sluggish (call it 2%) growth and persistently high, increasingly structural (and therefore protracted) unemployment…Emerging economies will achieve higher growth (in the 6% range), and their income and wealth levels will continue to converge with those of advanced economies.

Six countries, half of global growth
That growth differential will have profound consequences. The World Bank reckons that over the next 15 years, six countries will contribute more than half of global growth: The BRICs (Brazil, Russia, India and China) plus Indonesia and South Korea.

With that said, economic growth isn't a panacea for investors in slower-growth developed economies. In analyzing long-term stock returns across numerous countries, three academics from the London Business School found that "the supposed link between economic growth and stock-market performance is statistically weak and often perverse. Unless an investor is blessed with clairvoyance, there is no evidence that GDP growth is useful as a predictor of superior stock-market returns." (If you are blessed with clairvoyance, don't waste your time reading this article; if not, read on.)

Mind the valuations
In order to capture economic growth, part of the key is not to overpay for emerging-market stocks. When an asset class is overvalued, you want to be under-allocated, but that doesn't appear to be the case for emerging markets today (on an aggregate basis, at least). Asset allocation experts GMO, who are intensely valuation-focused, estimate that emerging market equities will produce annualized real returns of 4.5% over the next seven years. That compares very favorably with large-cap U.S. stocks, with an annualized loss of 0.5% (not to mention U.S. small-caps, which GMO expects will lose one-fifth of their real value over the next seven years.)

Emerging-market blue-chips
In that context, are you prepared for the shift that is taking place? Do you know all of the names in the following table, for example? All of them are blue-chip companies in their home country – the equivalent of Exxon Mobil or JPMorgan Chase – and they look reasonably priced, at first glance:

*As of May 27, 2011. Source: Capital IQ, a division of Standard & Poor's.

I realize that Banco Santander is domiciled in a developed country -- and a troubled one at that -- but the bank generates half of its revenues in Latin America. That said, investors should be extremely cautious in assessing Santander's prospects, due to its exposure to the European sovereign crisis. That's another key aspect of intelligent international investing: Multinational companies are borderless – what matters is not domiciliation, but where they do business. When you buy Wal-Mart (NYSE: WMT) shares, you're not betting on the economy of Arkansas; in addition to the U.S economy, you're getting exposure to faster-growing foreign markets, too. Nearly a third of Wal-Mart's assets are dedicated to non-U.S. markets.

A real alternative to U.S. stocks
Incidentally, I suspect the inability to accept this re-balancing in economic heft is one of the reasons some investors are resorting to putting money into precious metals through products such as the SPDR Gold Shares or the iShares Silver Trust (NYSE: SLV). These investors cite the U.S. government debt burden and the decline of the dollar. If that is your primary concern, why not invest in South Korean or South African equities instead? Both countries have impeccable sovereign balance sheets and you'll get a positive boost from any drop in the dollar's value. Who'd have thought?

Looking for more international stock ideas? Check out " This Stock is Set to Soar, as China's First Global Brand Emerges ."