- Christian Armbruester
Emerging or Submerging Markets
It is a little known fact that the so-called emerging markets now make up more than half of the world’s GDP. Whereas everyone seems to be focused on China and the incredible success story of their economy, other growth wonders like Brazil, India or Mexico are also projected to surpass the old-world stalwarts of France, Germany and the UK within the next two decades. Yet, when it comes to investing in equities, the emerging countries have underperformed the developed world by an astonishing 117% since the great crisis. How can we explain this, and is this one of the great potential investment opportunities of this century?
Maybe. Whereas growth will most certainly drive performance in the long run, it is also the development of the currencies that we have to take into account. For example, the Indian Rupee has lost 67% against the US Dollar during that same period, and the Brazilian Real has weakened 131% since 2009. Can we hedge the currency risk? Sure, but there is a high cost as a function of the interest rate differentials and execution fees. So if you are going to invest in emerging markets, you might as well do so in the local currencies as it is a large part of the risk.
There is also some argument that with the rising volume of economic activity, the recent underperformance of the currencies could revert. Meaning, we could make money not just from the growth in company valuations, but also from buying in at historically low exchange rates. There really is a lot to like about investing in emerging markets and the timing could be just about perfect, but there is always that question of decoupling and when is it finally going to occur?
You see, the equity markets around the world are all tremendously correlated. In essence, all the markets follow the lead of the biggest and ultimately most powerful market in the world, the US. Typically, US equities account for more than half of the allocations in most investment portfolios, and on sheer volume alone, the S&P 500 stands head and above any other index in the world. The US is pretty much all that matters when it comes to equity investments, and whatever happens there will happen everywhere else as well. So, until the emerging markets are finally able to break free and go up when the US goes down, it’s like marrying the poor cousin, and we are better off waiting for the big event to occur before ploughing in at the wrong prices.