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Emerging Markets Not Part of Stocks' Rally

Stocks in this article: EEM

NEW YORK ( TheStreet) -- Investors with long-term time horizons tend to look at stock exposure in emerging markets as a guaranteed win. But when we look at this year's conspicuous underperformance in the BRICs benchmarks (in Brazil, Russia, India, and China), it starts to become clear that those investing in these regions need to exercise conservative caution.

When we look at most financial headlines, optimism continues to be the central theme. Stock benchmarks in many developed nations have shown double-digit growth on the year, with the S&P 500 and Dow Jones Industrials gaining more than 20%. Even in Spain (a nation with unemployment rates above 26%), the Ibex has moved higher by nearly 4%.

Stock values in emerging markets, however, show an almost reverse image of this positive outlook: Brazil's Bovespa has dropped by more than 20%, the Shanghai Composite Index (SHCOMP) has fallen by 9.8%, and the broader iShares MSCI Emerging Markets Index ETF (EEM) is now showing losses of more than 11%.

When we look at the net worth of positions held by those invested in assets tied to the SHCOMP, we see losses of nearly three-quarters of a trillion dollars relative to the highs seen in 2009. These trends show that the days of easy buy-and-hold strategies for emerging market investments are behind us, and that continued outperformance in developed markets should be expected.

China Weakness

Some of the most striking signs of weakness can be seen in China. Prior rallies in the SHCOMP were generated by massive stimulus programs, which pumped more than $650 billion into new construction in railways, housing, and roads. Since hitting its peak in 2009, the index has fallen over 40%. At the same time, the S&P 500 has regained all of the losses posted after the credit crunch in 2008 and continues to push new record highs. And when we look at the macro picture, there is little to suggest these trends will end any time soon.

China is now set to grow at its weakest rate of expansion since 1990 as government imposed restrictions will require 1,400 factories to be closed in an effort to phase out obsolete and excess production capacity. In 2009, five Chinese companies ranked in the top 10 world's largest firms by market value. Last month, no Chinese companies were on that list. Stated goals for the Communist Party show a clear intention to rein in the nearly $2 trillion lending boom that started in 2009, which created bubble-like housing prices and record debt liabilities for local governments.

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