No one would blame you -- or any investor -- for wanting to forget 2008. Thanks to the collapse in share price of major financials such as JPMorgan Chase (NYSE:JPM), Bank of America (NYSE:BAC), Citigroup (NYSE:C), and Wells Fargo (NYSE:WFC), the S&P 500 lost 38%. It was, however, even more painful for international investors, particularly for those with exposure to emerging markets.
The Chinese stock market dropped 65%, the Indian market was down 52%, the Brazilian market slipped 41%, and Russian investors watched helplessly as their holdings collapsed 72%. It was a rough year.
So much decoupling
The emerging markets of China, India, Brazil, and Russia were supposed to hold up even if the U.S. stock market sputtered, but that didn't come to pass. With the U.S. market down, economic activity slowed worldwide, and today the whole globe shows signs of recession. There are even mumblings about negative GDP growth in China!
This is all sad and agonizing, but investing is all about looking ahead. So what do we at Motley Fool Global Gains see in our emerging-markets crystal ball?
Similar but different
Even with significantly reduced growth expectations, the emerging markets look appealing compared to developed markets. The IMF is forecasting GDP growth for emerging markets to fall to around 5% in 2009, but that is booming compared to the zero or negative growth expected in mature markets like the U.S., Japan, and Western Europe.
Now, saying emerging markets will grow by 5% next year is nice, but it doesn't really tell the whole story. Just like Bill Gates walking into a bar will make the average (mean) patron a millionaire, some emerging markets have brighter short-term forecasts than others. So which markets will rebound first? There are no guarantees, but there's at least one thing to look for when considering emerging markets.
Drumroll, please
Countries that import more than they export, like the U.S., run a current account deficit, which can reduce the strength of their local currencies. A falling currency translates into rising prices on imported goods, and higher debt costs on foreign debt.
Large current account deficits can be tolerated, as long as foreign investors are interested in buying assets in your country. But with the reduced risk tolerance in today's markets, direct investment in emerging markets is evaporating.
Eastern European countries like Romania, Turkey, and Hungary currently have account deficits of 14.5%, 6.7%, and 5.5% of their respective gross domestic products. On top of this, each of these countries has more foreign debt maturing in the next year than it currently holds in its foreign currency reserve. This isn't exactly a recipe for economic superstardom.
Who got it right?
During the boom years between 2002 and 2007, some emerging-market governments were applying lessons learned the hard way. They put in place policies that set them up for a rainy day (or week or year). Chile's government took advantage of historically high copper prices and created a $20 billion reserve fund, which they are now drawing from to provide stimulus for their economy.
Similarly, the Russian government has been able to support banks and large mining companies hurt by the credit crunch, thanks to the national welfare fund of some $200 billion and foreign reserves of $426 billion. Both are funded by the profits from high oil and commodity prices. Of course, with the Putin model of hands-on corporate assistance still in full force, we're not sure investors are exactly jumping for joy in St. Petersburg.
Governments in southeast Asia learned from the 1997 Asian meltdown, and foreign debt now makes up only 17% of emerging Asia's GDP, well below the 51% seen in emerging Europe. Put it all together and Asia and Latin America seem best positioned to weather this financial upheaval.
Another country, another story
It's important to realize, however, that within these regions there are countries with very different circumstances. China, for example, announced on Wednesday a $120 billion proposal to expand insurance coverage across China and increase access to health care in both rural and urban areas.
This is a big step forward for the country, and it should yield benefits for investors, but it's certainly not an expenditure that every other (read: any other) emerging market could afford to make. Of course, that's one of the reasons China remains an appealing emerging growth market in our eyes, despite the seeming collapse of its export economy amid this global economic downturn.
But back to those benefits
First, let's remember that one of the reasons China has not gotten caught up in this worldwide subprime crisis credit crunch is because its citizenry, thanks to decades of careful saving, is generally flush with cash. Indeed, according the CLSA data, the average Chinese middle-class couple saves some 20% of its income!
Now, there are good reasons why the Chinese have heretofore been reluctant to spend. First, the lack of mortgage availability means they must accumulate a tidy sum before they can purchase a home. According to that same CLSA dataset, just 17% of middle class Chinese homeowners took out a mortgage. Then there is the rising cost of education. And finally, since China currently has a pay-as-you-go health care system, there was always the need to keep savings on hand in case of a medical emergency.
With a new, expanded health-care system, the Chinese government seems to be trying to kill a few birds with one stone. First, by providing a better, broader health-care safety net, it may help stem some of the social unrest brewing in the country as a result of factory closures, reduced wages, and unemployment. Second, by providing citizens with a great sense of security, it may encourage them to start spending some of their savings. That, in turn, would spur domestic consumption, and perhaps help stave off a lasting economic downturn. Finally, it would ostensibly send some business to domestic manufacturers such as Mindray Medical (NYSE:MR) and China Medical Technologies (NASDAQ:CMED), which the government has stated its intent to support.
Happy hunting
One key to remember in a trying investment climate like this one is that cash is king...and that applies to countries just as it does to companies. Cash provides confidence, flexibility, and perhaps most importantly, the ability to borrow at lower rates.
That was this week in the emerging markets. To learn more about some of the best opportunities in the emerging markets today, check out "One Heckuva Cheap Stock."
