Submerging Markets – the downside of developing economies

Over the last several years, investors became accustomed<br /> to the belief that the influence of the U.S. economy and its policies<br /> on the emerging markets nations was waning. The emerging markets<br /> countries include the well-publicized BRICs group of countries (Brazil,<br /> Russia, India, and China) but also nations such as Indonesia, Mexico,<br /> Thailand and South Africa.


Navigating a Sea of Opportunity

Investment GuidanceOver the last
several years, investors became accustomed to the belief that the
influence of the U.S. economy and its policies on the emerging markets
nations was waning. The emerging markets countries include the
well-publicized BRICs group of countries (Brazil, Russia, India, and
China) but also nations such as Indonesia, Mexico, Thailand and South


stock markets of these countries have underperformed the U.S. markets
substantially over the last three years. This underperformance is based
on a number of factors. First, many of the emerging markets nations
were influenced by the China-led commodity boom. With China’s economic
slowdown, commodity prices have weakened and this has crimped growth in
much of South America.

have to look no further than Brazil — the second largest emerging
market economy after China — to see how quickly hope can turn to
despair and fear.  For the better part of 10 years, Brazil was
able to ride the twin rails of a boom in commodity prices brought about
by strong demand from China and a wave of private credit expansion.
Throw in a government with the means and will to spend and it made for
a pretty good economic story. Global capital flows liked what they saw
too as investors poured money in so quickly that Brazil instituted a
tax on money coming in to try to keep the Brazilian currency from
rising too quickly. As the economy has slowed, the hangover from excess
credit and money is causing a hangover. The central bank and government
of Brazil are trying to reduce private credit and government spending
while trying to maintain the country’s impressive track record in
recent years of moving citizens from poverty.
Canadians investing in emerging markets

further challenge facing the emerging markets is coming from the
currency markets. As the chart shows, investors have seen substantial
declines in the currencies of the emerging markets in the last four
months.  This is accelerating the flight of capital from the
emerging markets. Part of the currency upheaval is coming from the U.S.
Federal Reserve signalling its intention to begin withdrawing stimulus
from the financial markets. Markets are anticipating that a withdrawal
of stimulus will lift US interest rates and the US dollar. In turn,
this will make investment abroad less attractive — all things being
Historically, one of the remedies available to a country facing a run
on its currency is to raise interest rates which is designed to make a
currency more attractive. The dilemma is that if the emerging market
central banks choose to defend their currencies with higher interest
rate policies then it would begin to undermine economic growth. But if
they do not see some relief on the currency front, this will eventually
invite inflation for those countries whose economies tend to run
current account deficits due to higher levels of imports.

Looking at this brief outline of the challenges facing the emerging
markets, it would be easy to ignore them from an investment
perspective. However, it can be argued that these countries are worth
some consideration for inclusion into investor portfolios. Combined,
the emerging market economies contribute slightly more to total global
GDP than the developed countries. However, for the first time since
2007 the developed countries will contribute more to global growth in
2013 than the emerging market nations.

As investor capital has moved from the emerging markets to the U.S. in
record amounts in the last several months, it has created a valuation
story in the emerging markets. Some of these countries are seeing their
stock markets trade at a lower Price–to-Book valuation than during the
financial crisis. At the very least, the panic has created an
opportunity for investors to consider adding exposure to non-North
American assets to their portfolio.

Management Inc.

Navigating a Sea of Opportunity

report is for information purposes only and is neither a solicitation
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information contained in this report has been compiled from sources we
believe to be reliable, however, we make no guarantee, representation
or warranty, expressed or implied, as to such information’s accuracy or
completeness. All opinions and estimates contained in this report,
whether or not our own, are based on assumptions we believe to be
reasonable as of the date of the report and are subject to change
without notice. Past performance is not indicative of future
performance. Please note that, as at the date of this report, our firm
may hold positions in some of the companies mentioned. 

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