Emerging Markets Are Still a Buy
Oranges were once expensive luxuries in northern climes. “In 1916,” Paul Fussell writes in Abroad, “oranges, like other exotic things that had to travel by sea, were excessively rare in England. If you could find them at all, they cost the shocking sum of 5d each.”
Today, we take for granted that we can eat apples and oranges and bananas all year round if we choose. It doesn’t matter where you live. We can eat strawberries in the dead of winter. In fact, we routinely enjoy goods that come from places very far from our own doorstep.
“Televisions from Taiwan, lettuce from Mexico, shirts from China,” William Bernstein writes in A Splendid Exchange, a book on trade. Goods from faraway are so common, “it is easy to forget how recent such miracles of commerce are.”
Such miracles of commerce have redrawn the economic map. The emerging markets have “emerged,” as you will see. For you and me a big opportunity has also emerged in something called the Great Convergence.
Our story has its roots in the late 20th century, with the gradual spread of the Industrial Revolution to the developing world. According to Power & Plenty, a good reference book on trade, the Western world (ex-Japan) represented 90% of the world’s manufacturing output as late as 1953. America’s economy alone was nearly half of the world’s industrial output.
During this time, the economic gap between, say, China and Western Europe grew very wide when viewed in historic terms. But things changed in the late 20th century. The Great Convergence began. From 1950 on, world economic growth was, according to Power & Plenty, “quite simply astonishing.” We enjoyed a rolling wave of “economic miracles” through the decades. Closed economies opened up…and trade expanded.
We can point to the success of postwar Japan…and then to the surging tiger economies of East Asia. Singapore, Hong Kong, Taiwan and South Korea grew in leaps and bounds. Finally, we saw the opening up of China, India, Russia and Brazil. The once-bottled-up energies of these countries poured out.
Today, we see the handiwork of the Great Convergence taking shape. The distinctions between “emerging markets” and “developed markets” are starting to disappear. Indeed, the terms may already be obsolete. Such is exactly the thesis of Everest Capital, which makes the case in a recent white paper called The End of Emerging Markets?
“The belief that companies in the US, Western Europe or Japan are better managed than in emerging markets is also no longer valid,” Everest asserts. “Anyone who has sat through the parade of fraud and corporate malfeasance of recent years in the US will find it hard to argue otherwise.”
The list of corporate thieves is much longer in the US and Europe than in the emerging markets. Management teams in the West no longer dominate when it comes to standards of best practices. Everest speaks with the authority of a practitioner on this point. “We meet a large number of managements in emerging market countries, and it is impressive to see how quickly they have adopted best practices in terms of disclosure, governance and creating shareholder value.”
Everest also makes the case that governments in the West are just as bumbling as those of emerging markets. More and more, it is the Western governments that steal too much. Another distinction blurred.
Emerging markets now make up about half of the global economy. Take a look at the nearby chart, “Let’s Call It Even.” (Gross domestic product is a flawed statistic, but it serves as a rough guess of economic size. PPP means “purchasing power parity,” which aims to take out the distorting effect of different currencies.)
Not surprisingly, therefore, emerging markets now make up 10 of the 20 largest economies in the world. India is now bigger than Germany. Russia is bigger than the UK. Mexico is bigger than Canada. Turkey is bigger than Australia.
In a stock market sense, these places have also grown up. It used to be that emerging markets were not very liquid or very big. It was not that long ago that the IBM shares changing hands in a single day in New York were worth more than all the shares that traded hands in Shanghai or Bombay.
Today’s emerging markets are large and liquid. As Everest Capital points out: “In the third quarter of this year, Chinese markets traded more shares than the NYSE; Hong Kong and Korea traded more than Germany; India traded more than France; and Taiwan traded more than Italy, Australia or Canada.”
Emerging market companies are also growing faster. In particular, there are wide gaps in the growth rates of sales and profits. The second key distinction worth noting is that of balance sheet strength. Emerging market companies have less debt and cover their debts more comfortably.
All is to say, investors need exposure to emerging markets, or at the very least, they should not shun them for reasons that are no longer valid. One of my favorite ways to get exposure to emerging markets is through the back door, so to speak. Invest in companies, wherever they are, that have what these economies need or want, but don’t have – or can’t make. This is another reason to invest in the commodities we’ve honed in on – especially oil, potash, gold and the agricultural commodities.