Beware of Emerging Markets

Never before in history has the world experienced such synchronized growth. Improvements in communication and transportation, along with a reduction in duties and tariffs have made trade an important part of the global economy. When one country experiences rapid growth, its imports rise benefiting the economies of its trading partners.

Compounding this is that we are living in a fiat money world that is fueled by US debt growth. American consumers are buying goods on credit from around the world. Other nations are happy to sell their goods as long as they believe they will eventually be repaid. So both US consumption and foreign production are able to carry on at a brisk pace leading to a synchronized global expansion.

This interdependence can be seen in the similarity of the charts of stock markets around the world:

sp500german_dax_compositejapan_indexchina_indexindia_sensexbrazil_bovespa

What is clear from these graphs is that although the timing of the price gyrations are identical, emerging markets seem to experience greater gyrations. This should not be surprising. Emerging markets are comprised of companies that generate less revenue and operate at thinner margins than those of developed countries.

In the past few years, rising liquidity has benefited companies across the world. But Brazilian, Chinese and Indian stocks have been able to outperform American, German and Japanese stocks.

The reverse can also occur. When money becomes tight — like I believe will soon happen due to further weakness in US housing and an unwinding of the yen carry trade — stocks around the world will fall with the greatest declines being experienced by emerging markets. The period from May to June of last year offered a taste of this.

It may be difficult to realize under present conditions, but volatility can cut both ways. Unfortunately, many emerging markets investors will soon learn this the hard way.

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