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A Fork in the Road for Emerging Markets

Money could rotate to countries with current account surpluses, such as Malaysia.

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.

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



iShares MSCI Malaysia


and the closed-end

Malaysia Fund


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


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


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.

The iShares fund has a beta of 0.46 and yields 3.8%; its compatriot yields 1.9% with a beta of 1.54. The numbers don't justify choosing the risk of the closed-end fund.

The ringgit was decimated during the Asian financial crisis of 1997. Before the meltdown, it took 2.5 ringgit to buy a dollar. Afterward, it traded at 4.75 ringgit to the dollar, though it soon recovered to 3.5 ringgit. A repeat of this is highly unlikely, but it's not impossible, either.

I'd advise putting no more than 3% of your portfolio in such a market -- if it blows up, it would be unfortunate, but not ruinous.

Emerging markets, an asset class that has worked so well for so long, may be splitting into haves and have-nots. If a divergence persists, it may make sense to rotate your capital within the asset class rather than rotate out of it.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. At the time of publication, Nusbaum had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;

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