Re-Emerging Markets

“Buy me 10,000 shares of Hopewell Holdings in Hong Kong right now!!!”

“Yes sir! By the way, my name is Stev-“

“I don’t care who you are, just get that order in!!!”

Welcome to my first investment “bubble”. It was late 1993/early 1994, and I was a broker specializing in international stocks…which means I was in the right place at the right time. Hopewell and other stocks like it had doubled, and were literally going up every day. The phones were ringing off the hook, and people were buying indiscriminately.

It was the emerging markets bubble. And while not as many people participated compared to the more recent dot-com bubble, the gains were just as spectacular. Stocks doubling and doubling again like Hopewell were everywhere. And even boring funds, like the big fund of the day, the Templeton Emerging Markets Fund, were up substantially – 359% in the four years to the peak of the bubble in January of 1994. Then the bottom fell out…

The Hang Seng Index (Hong Kong’s main stock index) lost 38% of its value over the next twelve months. The hits just kept on coming to emerging markets like Hong Kong.

Emerging Markets Bubble: Nobody Cares

In late 1997, the Asian Crisis hit. Then Russia defaulted in 1998, the Nasdaq started tanking in 2000, Argentina defaulted on $95 billion in December of 2001, and now we’re on the brink of war in 2003. That’s nearly a decade of uppercuts and punches in the gut. Can it get any worse for emerging markets?

Nobody cares about emerging markets any more. Yet ten years ago, they were all the rage. They could do no wrong. It couldn’t get any better. I bring this up because this is the typical sequence of “bubble” and “bust”. This sequence plays itself out regularly around the investment world. As Leon Levy subtly puts it in his new destined-to-be-classic investment book, “The Mind of Wall Street”, “Investors overreact, and so do markets. Investors get swept up in moods, and so do markets. And this interplay creates investment opportunities.”

Levy says we all live three lives – our life, the life of our parents, and that of our children. And the events we’ve been through, particularly in our youth, are most deeply branded on our minds. If you didn’t live through the Depression, and your parents didn’t live through the Depression, the Depression isn’t as real to you. Levy gives an example:

“I might warn a [new kid on Wall Street] incessantly about the horrors of a crash or a bad market. But I will not likely make an impression on one who hasn’t lived through that experience.”

The experience right now we think will last indefinitely. We think now is the way it is. But it is not.

Emerging Markets Bubble: “A Permanent Period of Prosperity”

At the end of the Roaring Twenties, Yale economics professor (and stock market speculator) Irving Fisher famously proclaimed that we’d reached a permanent period of prosperity. He made his statement on October 17, 1929. Twenty full years after his famous words, the Dow was still 46% lower than when he talked of permanent prosperity.

On August 13, 1979, BusinessWeek ran a cover story on “The Death of Equities”, saying, “The death of equities looks like an almost permanent condition.” Up until then, stocks had been floundering for a dozen years. And BusinessWeek stated, in all seriousness, that “…the truth is that Wall Street’s future still is very much in doubt.”

Exactly twenty years after that cover story, the Dow had risen an astounding 1,154%.

Irving Fisher and BusinessWeek were both ridiculous, in hindsight. There is no permanent plateau of prosperity – booms and busts are part of human nature. And there is no death of equities – investing yourself in a venture to build something is also part of human nature.

But recently, there’s been talk about the death of the “sovereign” debt markets – and specifically the market for the bonds of emerging market countries. Standard & Poor’s estimated in late September, 2002, that “the average issuer default rate on foreign currency bond and bank debt is one of the highest on record for nearly 180 years”. More recently, on February 1, 2003, The Economist Magazine quoted a paper by a Harvard economics professor entitled “Will the Sovereign Debt Market Survive?”

With Russia’s default in late 1998, the market for emerging market bonds was obliterated. The market literally froze up – ceasing to function, for a while. There were no bids – no buyers. If you wanted to sell, too bad. Not a single investor would step up to the plate to buy what you were trying to sell – at any price.

Emerging Markets Bubble: A Russian Sideshow

Interestingly, the bursting of this little bubble had nothing to do with the underlying asset. The fact that Russia was defaulting was a sideshow to what was really going on. And that was the crash of a hedge fund called Long-Term Capital Management. The U.S. Federal Reserve had to step in and engineer a bailout of the world’s financial system. (For the fascinating story, read the book “When Genius Failed” by Roger Lowenstein.)

Since then, emerging market bonds have been a shadow of their former selves. Burned by rising defaults, investment banks have simply pulled up stakes and fled. As the quote from Standard and Poor’s suggests, we’ve seen more debt defaults by countries in the last 15 years or so than we have at any time in recorded history.

Now remember Leon Levy. Remember that what we experience is what we believe. Our instinct says “mental note: stove hot, don’t touch again”. We don’t generally look back over 180 years at the history of touching stoves.

The truth is, the history of emerging markets is one of non- stop booms and busts. People start dreaming about big promises and immense potential riches from far away lands, and they want to get involved. Like other bubbles, the word spreads, and pretty soon, everyone is buying. At some point, people are willing to pay ridiculous prices for investments in foreign lands. And inevitably, it seems, at some point the bottom falls out. That’s how a foreign country ends up staying an emerging market.

This is the reality of emerging markets. There are booms. There are busts. And then after the busts, there are the “purgatory” periods, as we’ve seen in emerging market bonds for the last five years.

The very best time to invest is when an investment category becomes immune to bad news. Nothing bad can hurt it anymore. And this class has become immune to bad news. The $95 billion Argentina default of late 2001? No big deal. War in Iraq in 2003? No big deal.

But judging by today, we have a fair guess as to what might be the next “big deal” in tomorrow’s news…

Happy investing,

Steve Sjuggerud,
for the Daily Reckoning
February 26, 2003


Last week, it was the Canadian dollar that made headlines as it rose against the U.S. brand. Yesterday, it was the Australian dollar’s turn; it hit its highest level since June of 2000.

Who cares?

“A small increase in interest rates or depreciation of the U.S. dollar could cause catastrophic consequences,” concluded an article at Finance

The dollar has been depreciating since the Fed Reserve was set up to prevent it from doing so. But its most recent down-swoop began after Fed governor Ben Bernanke told the whole world the Fed’s dirty little secret: “we have a technology called a printing press…[which allows us to increase the world’s supply of dollars] at virtually no cost…”

A modest decline in the U.S. dollar may be hardly noticed…but an immodest decline sends foreign dollar- holders looking for cover. Recently, for example, it was reported in the International Herald Tribune that Russian kidnappers were asking for their ransom money in euros rather than dollars.

Foreign lending is crucial to the U.S. economy. At the margin, it is foreign investors who fund the home refinancing boom as well as the federal deficit. When the foreigners pull away from dollars it reduces the amount of available capital and forces up lending rates.

In the second half of 2002, Finance reports, the average U.S. homebuyer made a down payment of only 7% of the purchase price, and uses 40% of household income to pay the mortgage. Housing prices are the highest percentage of average earnings in U.S. history, while the homeowner’s equity is the lowest it has ever been.

“This is unsustainable,” the article continues, “and will end just as badly or even worse than the tech bubble did.”

But how? So far, home refinancing has saved the U.S. economy – but only by luring the homeowner deeper into debt. Sooner or later, someone will be ruined by it – either the fellow making the loan or the fellow taking it. Maybe both. Either the burden of debt will be eased by Bernanke’s printing presses…or it will crush the homeowner as real rates rise in a deflationary slump. We’ll have to wait to find out… In the meantime, here’s Eric Fry with the latest news:


Eric Fry, on the scene in New York…

– Yesterday, Mr. Market demonstrated once again why he is such an interesting fellow. After stumbling more than 150 points during the morning, he came charging back during the afternoon. The Dow finished the day with 52-point gain at 7,909, while the Nasdaq added half a percent to 1,329.

– Meanwhile, the safe-haven investments that attracted investors on Monday suffered a reversal of fortunes yesterday. Spot gold slumped $5.90 to $351.85, while energy prices retreated from Monday’s multi-year highs. Crude oil fell 42 cents to $36.06 a barrel and heating oil dropped more than 2% to $1.126.

– The stock market’s one-day wonder won’t do much to cheer up the beleaguered consumer…The poor lump can’t seem to catch a break. First his tech stocks blow up, then his job disappears, then his tech stocks blow up again…And all the while, he has to watch his “idiot” neighbor get rich buying gold stocks!…It’s just too much to bear.

– No surprise then that Consumer Confidence Index tumbled yet again in February – to a reading of 64.0 from 78.8 in January, marking a fresh nine-year low. The “present situation” component and “future expectations” component both tumbled a similar amount.

– “Lackluster job and financial markets, rising fuel costs, and the increasing threat of war and terrorism appear to have taken a toll on consumers,” reads the boiler-plate assessment from Lynn Franco, head of the Conference Board’s consumer research center. Franco must have the easiest job in America. Once a month she emerges, glockenspiel-like, to toll the dolorous message of waning consumer confidence. – Many State and local governments are faring as badly as the woebegone consumer. Anecdotes of municipal distress abound, like this one from the Daily Reckoning discussion board: “A local small city near me [in New York state] announced a financial problem this year…In 2002, its contribution to the state retirement system was $32,000, and this covered all their retirees, past and future. This year, the state has informed the city that because of the shortfall in the funds invested by the state of NY, its share will be $762,000 for the 2003 fiscal year…This city expected a problem, so they budgeted $300,000, which is almost 10 times what 2002 cost and were still caught short by over 50%.”

– The story-teller goes on to explain that the small city fears a $1 million shortfall in 2004. “This is a city of 10,000 people,” he writes, “so where will this extra million come from? I expect to see them cut Parks and Recreation budgets and jack up every taxpayer’s taxes by 50% to keep things afloat for a while longer…At this time a $100,000 property costs almost $4,000 in taxes and insurance in this small city. So where are they going from here when the average homeowner has to pay $350 a month in taxes and insurance before he/she pays the principal or interest on their mortgage?”

– Good question. This “small city’s” experience may be extreme, but it is hardly unique. State and local governments are facing increasingly severe budget crunches. And as desperate times call for desperate measures, many states are resorting to dubious revenue-generation tactics.

– “Local governments around the nation are taking a new look at some old vices,” says CBS Marketwatch, “encouraging everything from gambling to nudism in return for more jobs and fresh revenue streams.”

– The governor of Maryland, for example, hopes to raise about half a billion dollars per year by installing 10,000 one-arm bandits in the state. Seventeen states in the union have legalized gambling. Many more are reaping the benefits of a growing porn industry – aka “adult entertainment”. Pornography – long rumored to be a popular pastime among the nation’s lawmakers – is now gaining favor as an all- season revenue-generator. Many states, says CBS Marketwatch, “quietly benefit from their relative toleration of strip clubs and other adult entertainment emporia, drawing customers from nearby communities where the businesses are more frowned upon. Few governing bodies (at least outside of Nevada) like to be seen marching hand- in-hand with the adult entertainment industry…Still, there is money to be made…”

– Indeed!…Porn is the ultimate budget-friendly industry – – fast-growing and recession-proof. What’s not to love? The solution to our national budgetary woes is obvious, isn’t it? Let’s convert all of the country’s McDonalds and Starbucks outlets into “adult entertainment kiosks”. (“It’s a Wonderful Life” be damned! Our states need the cash!) Then we’ll just sit back and watch the state coffers gush to overflowing.


Back in Paris…

*** Sitting in the JFK airport, CNN was unavoidable: “We’re at panic levels in the stock market,” said one dim analyst. “When people are this negative, it is almost always a good buying opportunity.”

Panic levels? With stocks at nearly 30 times earnings?

*** It was still mid-winter in Baltimore, with snow piled up in parking spaces…but here in Paris it is early spring. The sun is shining…people are sitting at outdoor cafes…nice weather for a picnic, or a war.

*** Le Monde reports that the U.S. expelled its first newsman:

“Even at the height of the cold war,” says Le Monde, “that never happened. Since the U.N. came into existence, certainly spies wandered about with press cards, but never was an accredited journalist expelled from the host country. But a new precedent has just been created. Mohammed Hassan Allawi, a correspondent for the Iraqi Press Agency, and the only Iraqi journalist on American territory, has been told to leave New York before the 28th of February.”

*** “It’s easy for people in the safety of their American armchairs,” writes my friend Harry Browne, “to tell how courageous other people should be – that they should stand up to tyranny, endure torture, sacrifice themselves. It’s easy when you never have to face the same choices.”

The Daily Reckoning