A Fork in the Road for Emerging Markets

Lately, emerging markets have divided into two camps: those with and those without current account deficits. It's the former countries that have been getting all the attention of late, chiefly Iceland, Hungary and (although it's not really an emerging market) New Zealand.

These countries have been for sale, but I don't think those who raise cash will leave emerging markets. Given the flow of money into the sector over the past few years from pension funds and endowments, it's likely to stay there, and, I think, rotate into countries with current account surpluses.

One candidate is Malaysia. Its current account surplus was $4.82 billion in the fourth quarter, and the Malaysian central bank predicts GDP growth will be 6% in 2006. The bank attributes this growth to exports of electronics and oil.

It isn't talked about much, but Malaysia produces slightly less than 800,000 barrels of crude per day; it consumes less than 500,000 barrels a day and exports the rest. Malaysia also exports natural gas.

The numbers are small, but they're a nice boost for Malaysia's GDP, which is about $250 billion.

As the deficit currencies have blown up, the Malaysian ringgit has strengthened 2.3% against the dollar.

Even though the economy has a high growth rate and the currency has been strong, interest rates are still low. According to Bank Negara Malaysia, two-year government securities yield 3.54% and 10-year government securities yield 4.15%, compared to 4.80% and 4.84% for the same respective maturities in the U.S. This indicates that the central bank is doing its job well.

As the chart below shows, the benchmark Budapest BUX index (in yellow) has been much more volatile and had a swift move down when the deficit theme first unraveled with Iceland.

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Sailing On While Budapest stocks (yellow) tanked in March in response to troubles in Iceland, Malaysian stocks were unaffected

Source: BigCharts.com

The ETF iShares MSCI Malaysia (EWM Quote) and the closed-end Malaysia Fund (MF Quote) have similar compositions. Their heaviest investments are in the financial and consumer sectors, with Malayan Banking Berhad accounting for 9% of each and Tenaga Nasional Berhad 5%.

Same Stocks, Different Results The Malaysia Fund (yellow) has been far more volatile than iShares MSCI Malaysia

Source: BigCharts.com

However, as you can see, the iShares fund has been relatively steady over the last three years, while the Malaysia Fund has had a nauseating ride, dropping almost 20% the last two springs. The iShares fund fell 10% over the same periods.