HAUKE: Now may not be best time for emerging markets

Many investors, either through their own choice or by following the advice of an adviser, diversify their investments in order to give them exposure to a variety of vehicles and asset classes.

The idea is to enjoy gains in one area when another area may be suffering. What do you do, though, when one of these asset classes has been lagging for quite a while and all prospects point to continued underperformance for months, maybe years to come?

This is the exact situation emerging market investors find themselves in, and they may not know what to do about it.

If you mention places like China or Brazil to people, most of them would think about growth and the opportunities to create wealth in such countries. The fact is that these countries are growing like crazy and massive wealth creation is occurring. Professional analysts from all over the world have been seriously attracted to these incredible growth stories and they have pointed millions of investors squarely at the stock markets of what one famous analyst coined the BRIC nations—Brazil, Russia, India and China. The problem these analysts and their investors would rather not face right now is these emerging market stocks have underperformed U.S.-based stocks for almost 18 months now, and the signs don’t look that good going forward.

At this point, the diversified investor might acknowledge the long-term lagging nature of emerging market stocks, but would point to their holdings of U.S. stocks as a counter. Maybe they think if U.S. stocks see some trouble that these up-and-coming countries will then pick up the slack. That stuff seems to work far better in theory than it does in practice.

Emerging market stocks were obliterated right along with the rest of the world in the last bear market in 2008. Emerging markets actually lost more last spring when we experienced an unusually long bull-market correction. And here is the insult: They haven’t bounced back as much as U.S. stocks since the market bottomed in July. I may not be a bloodhound, but I think I smell a trend here.

The bull market we are now experiencing kicked off in March 2009, making it almost two years old now. The average bull market lasts three to 3-1/2 years, with the Dow Jones industrial average typically doubling in price during that time. We are obviously not there yet in either performance or time, but the clock is ticking.

We could easily see another year go by with these emerging market stocks moving up, but not as much as U.S. equities. The real danger comes when the next bear market hits. Staying the course during the entire cycle could mean earning a lower-than- average return for the next year to 18 months, then getting hammered during the next bear market. That doesn’t sound like a course I want to stay on.

I realize there is a strong allure to keep money in a country like China, a place where GDP is growing about 9 percent a year. It will continue to be a smart decision for American businesses to try to sell products and services into these markets. The growth stories should continue for another 20 years, if not longer. The current risk lies directly with investing in the stocks of these countries, not with the countries themselves. It might be better to look more closely at investing in emerging market stocks when we approach the next bear market bottom, but that may not be for a few more years.•

__________

Hauke is the CEO of Samex Capital Advisors, a locally based money manager. His column appears every other week. Views expressed here are the writer’s. Hauke can be reached at 203-3365 or at keenan@samexcapital.com.