If you read financial news regularly, you will know that emerging markets are in a tight spot these days. From Argentina to Turkey to Indonesia, many emerging countries are under severe financial duress. Their currencies are in a free-fall, as are their equity markets. Just today, the headline article in Financial Times (5 Sep) screams: Emerging market slide spreads across developing world.
So the pertinent question this week is: How should you invest in emerging markets (EM)?
The Emerging Market Is A Diverse Lot
Before we delve into investing in EMs, there are some things you should know about ’emerging markets’:
- EM is a convenient term that groups together a diverse array of countries.
- Within this umbrella, there are financially (1) strong, (2) so-so, and (3) weak countries.
- Some EMs are economically larger than developed markets.
- Some EMs have capital or FX controls.
- EMs can move into developed statuses after many years of growth.
- Really risky EMs are called ‘Frontier Markets/Economies’.
Therefore, when someone talks about investing in EM, you should immediately ask yourself:
- Do you know anything about that region?
- Do you know anything about that particular emerging market?
- Have you travelled there before?
Very often, investors make the mistake of banding together all EMs without differentiation. Some EM are economically more sound than others. Some EMs economies are more diverse than others, meaning, they do not rely on a particular commodity such as oil or copper, to fund government spending. Some EMs also fall regularly into economic crises because of weak tax receipts or legacy debt problems or mismanagement. As such, you will need to do at least some homework before investing in EMs.
Another classic mistake that people make when investing in EM is not visiting the country. A first-hand account of the country is a always a good idea because it attunes you to the local issues like currencies, price levels, and governance. For example, when investing in Malaysia did you know the country just had a sea-change in politics in May?
Knowing the local EMs is the only the first step. The next key step to EM investment is timing.
Timing in Emerging Markets Investing
The first and only rule in EM investment is: Do not buy during boom times.
You will get burnt badly if you violate this rule. Because emerging economies are highly cyclical. This means that emerging economies will endure several boom-bust cycles. When things are booming, valuation rises to extreme. For instance, in 2017 Argentina sold $2.75 billion worth of 100-year bond with a yield of only 7.9%!* Argentina’s policy interest rate now? 60%!
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When an emerging country’s economy turns south, things get bad quickly. Not only that, the outlook is always worse than expected. Ergo, a massive panic will cause prices to fall much further than expected. During the 1997 Asia Financial Crisis, Korean equities crashed in USD terms by more than 80%! In Venezuela, inflation rate these days exceeds 10,000%.
If you have the patience to wait for an EM crisis, you will probably be able to pick up some extremely good bargains.
After a crisis comes to EMs, what to buy? Generally, I would stick to (a) large corporates, such as banks, telco, airlines etc, (b) conservative-run companies. To find out companies that satisfy (a) and (b), you will probably have to speak to some brokers from that markets because they have specialist local knowledge. Of course, to avoid stock picking, you can use country ETFs or regional Investment Trusts to gain exposure.
Thoughts On Current EM Rout
Things have really deteriorated quickly for many EMs this year.
If you recall, the market sentiment at the start of 2018 was that of a ‘Melt Up’. Now, we have a melt down. Venezuela, Turkey, India, Indonesia, and Argentina are all experiencing severe currency depreciation. One reason is debt, which led to increased monetary debasement. Even China was not immune from these broad currency devaluations.
However, developed markets are holding relatively well. Amazon hits the $1 Trillion valuation this week. Therefore, the contagion impact from EM has yet to hammer developed equities. This means that we have not seen the extremely bearish sentiment that accompanies a crisis.
In turn, I anticipate more downside risk for many EM markets (see Templeton EM Fund below).
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