Wednesday, July 29, 2009 6 comments ++[ CLICK TO COMMENT ]++

The price you pay for emerging markets

Jason Zweig writes the weekly Intelligent Investor column for The Wall Street Journal. I don't subscribe to the WSJ but this column seems to be freely accessible on the web every week. Sometimes the articles are good; sometimes they are not. For someone who is a fan of Benjamin Graham, he writes a lot of articles that are more suited for passive investors than stockpickers. Nevertheless, sometimes the articles are pretty good, like last week's.

In Under the 'Emerging' Curtain, Jason Zweig tackles emerging markets. More specifically, he quotes some study by Elroy Dimson that shows that fast growing emerging markets produced less profits for investors than slower growing ones. This isn't really news to me—it's like growth stocks versus value stocks—but some may find it surprising (as usual, bolds are by me):

Based on decades of data from 53 countries, Prof. Dimson has found that the economies with the highest growth produce the lowest stock returns -- by an immense margin. Stocks in countries with the highest economic growth have earned an annual average return of 6%; those in the slowest-growing nations have gained an average of 12% annually.

That isn't a typo. Over the long run, stocks in the world's hottest economies have performed half as well as those in the coldest. When Prof. Dimson presented these findings recently in a guest lecture at a Yale University finance program, "a couple of people just about fell off their chairs," he says. "They couldn't believe it."

But, if you think about this puzzle for a few moments, it's no longer very puzzling. In stock markets, as elsewhere in life, value depends on both quality and price. When you buy into emerging markets, you get better economic growth -- but, at least for now, you don't get in at a better price.


"The logical fallacy is the same one investors fell into with Internet stocks a decade ago," says finance professor Jay Ritter of the University of Florida. "Rapid technological change doesn't necessarily mean that the owners of capital will get the benefits. Neither does rapid economic growth."

High growth draws out new companies that absorb capital, bid up the cost of labor and drive down the prices of goods and services. That is good news for local workers and global consumers, but it is ultimately bad news for investors. Last year, at least six of the world's 10 largest initial public offerings of stock were in emerging markets. Through June 30, Asia, Latin America, the Mideast and Africa have accounted for 69% of the dollar value of all IPOs world-wide. Growth in those economies will now be spread more thinly across dozens of more companies owned by multitudes of new investors.

If you are top-down, like Jeremy Grantham, or driven by some macro thesis, like Jim Rogers, then it doesn't matter if you invest in high growth countries or not. But if you are simply doing it because the economic growth is forecast to be high, be careful...


6 Response to The price you pay for emerging markets

John Y
July 29, 2009 at 11:34 PM

You always find interesting articles. Well done!

Daniel M. Ryan
July 30, 2009 at 2:35 AM

Another plausible rule found wanting.

By the way: have you heard the recent talk about China being a bubble economy? 

Sivaram Velauthapillai
July 30, 2009 at 11:30 AM

Daniel Ryan: "By the way: have you heard the recent talk about China being a bubble economy? "

I have been bearish on China since probably 2006, when I sold my China ETF (FXI). Of course, I have been wrong since then but the bearish views don't surprise me.

I do notice that the bearish view is making it into the mainstream. However, the stock market is not pricing in such a view. Commodities have been strong this year even though they will get decimated if China posts, say, +3% GDP growth for a few years.

China is keeping their growth going by loaning a ton of money to almost any large business (most of them govt-owned). The question is what happens later this year when they curb loan growth. A similar problem exists over here. Right now, government stimulus plans in developed countries are helping the economy but I wonder what will happen when the stimulus dissapears. Usually the world recovers but we still have a huge overhang of indebted consumers :(

Daniel M. Ryan
July 30, 2009 at 12:15 PM

I'm watching it closely because I'm smelling "bubble." I may be wrong, but bubbles develop when markets [or economies] go up when common sense analysis says they shouldn't. That combo lends a magical aura, which punters thrive off.

Imagine the Chinese economy as a full-fledged bubble economy...

July 30, 2009 at 5:04 PM

This was in the WSJ heard on the street column Tuesday.  From Birinyi associates:

since 1970, S&P 500 has returned 10% annualized, 3% for diamonds, 6.5% for farmland, 5.8% for US homes, 8% for NYC taxi medallions, 16% from emerging markets shares.  It does not mention what emerging markets index or shares were used. 

I think that returns can vary significantly in annualised performance, when differing time periods are used.  You discussed this with gold in an earlier record.


Sivaram Velauthapillai
July 30, 2009 at 7:11 PM

Yep... I wonder what the data that is quoted by Zweig covers...

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