I have inserted a chart from a recent BCA Research report that shows emerging markets have recently been gaining strength. Historically, emerging markets gaining strength is a signal for a bottom in world economic downturns. The substantial relative strength shown in opposition to the U.S. indexes should be closely watched in the upcoming weeks. Continued strength and momentum could signal a fundamental bottom and growth around the corner.
China Stimulus Measures:
"Just as Britain was the country of the 19th century, the U.S. the country of the 20th century, China will emerge the country of the 21st century." These words from Warren Buffet are strong enough to stand in front of May turn out to be notorious enough for us to overlook Berkshire Hathaway’s recent 96% decline in Q4 FY08 profit. At China’s National People’s Congress, Premier Wen Jiabao promised GDP growth of 8% for the year. Although this percentage does not amount to the past decade of Chinese rate of growth, it will most definitely shine 8% greater than any developed economies for the year. I have confidence in this affirmation as Wen is on the brink of introducing China’s second stimulus plan in the past year.
A stimulus plan will be the key to bringing the world out of a global recession, however; it will not come from the United States government. This past Wednesday China’s benchmark stock index rose 6% on talks of another China stimulus plan in the creation stage. This news also sent the U.S. broader market higher, which gives indication that growth in Asia will lead to growth around the world. Other bullish indicators within Emerging Asia as of late is the strong rally in manufacturing commodities such as copper and iron ore. The copper futures market has been on a rally as an indicator that China’s economy and stimulus bill will spark production and growth.
After the Asia Crisis in 1997/98, many countries implemented structural changes to macro- and micro-economic improvements leading to stronger, conservative balance sheets. As investors have been leaving U.S. equities, they will look for investments that have not been dismantled by credit and leverage. The U.S., Euro-Zone, and Britain had the easiest access to credit, and they are hitting the ground the hardest. Countries without easy access to credit will turn into investment opportunities for the new financial environment. With a healthier macro-economic environment, Asia will be able to implement a stronger fiscal policy than developed regions.
Further looking into commodities, which across the board are currently at depressed levels, China and its net importers tend to benefit over other countries from this type of commodity environment, especially with lower energy prices. This will free up businesses and promote investment.
Emerging Markets Leading the Recovery:
The fundamental truth is that Emerging markets now account for half the world’s economic output, and 80% of the world population. However, emerging market stock capitalization only accounts for less than 15% of the world capitalization. In economics it is called market disequilibrium. In finance, I call it an investment opportunity.
I have inserted a chart from a recent BCA Research report that shows emerging markets have recently been gaining strength. Historically, emerging markets gaining strength is a signal for a bottom in world economic downturns. The substantial relative strength shown in opposition to the U.S. indexes should be closely watched in the upcoming weeks. Continued strength and momentum could signal a fundamental bottom and growth around the corner.
Strength behind the Great Wall:
I have highlighted China as the emerging economy to lead the turnaround for many reasons. With a population greater than 1.3 billion, the middle class continues to grow and become financially competitive. Wen Jiaboa stated the importance of “significantly increasing investment to simulate economic growth, improve people’s lives and deepen reform.” As I stressed earlier the conservative economic environment has ensured China’s financial freedom from toxic assets. It is also important to look at the export market as it was once a vital part of China’s economy. Today, China has allowed the Yuan to appreciate, and thus deviating from its prior export competitiveness. China will seek future growth in part by foreign investment and will not be leaning on the coattails of the developed world to purchase Chinese goods. These factors, along with the additive that the Chinese government lowered the corporate tax rate to 25% (from 35%) will ensure that China will be the boom that relieves the current bust.
Investment Opportunity:
To take advantage of this investment opportunity, my colleague, Addison Schroeder, believes the best way to gain diversified exposure to China is through the FTSE/Xinhua 25 Index ETF, FXI. Even though a few companies in this index are partially state-owned, the growth of China will still be reflected in the returns generated by the index. Addison is optimistic in the possibility that one day capitalism will take over socialism, and the state-owned companies will be able to take advantage of the free market system. For a more developed play on China Schroeder likes the MSCI Hong Kong Index ETF, EWH.
Emerging markets are still a high risk investment, however, from the decline in the emerging indexes over the past year, it may be the right time to jump in and participate in some bargain shopping. Emerging markets are a great fit in the wider portfolio as they offer a rare combination of value and growth.
- In respect to Addison's opinion on state-owned companies, I have a little more positive outlook. A recent article from the Economist describes that "the more "capitalist" an economy, the deeper the downturn. And the more the country is still in command, the better chance for recovery in 2009." State-controlled firms account for nearly 1/3 of the industrial production. These firms have been demanded not to cut jobs or capital spending. The Economist references that all major Chinese banks are state-owned, and "if they get a phone call telling them to lend more, they are likely to do so."
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