Debunking Anti-Emerging Market Arguments
NEW YORK (TheStreet) -- There's been something of an anti-emerging markets investing theme developing in a couple places, each relying, in part, on research from Elroy Dimson, Paul Marsh and Mike Staunton from the London Business School five years ago.
Financial writer Jason Zweig noted that "there's essentially no correlation whatsoever between GDP growth and future stock-market returns." Still, Zweig didn't come to that conclusion from the Dimson, et al., research. I wrote a blog post that was critical of his conclusion, and Zweig, in turn, shared the report with me. Chris Sholto Heaton wrote an article that was also skeptical about emerging-market investing, citing the same report.
Dimson and his cohorts concluded that few countries have ever "graduated" to developing-market status; emerging markets have underperformed developed markets by 100 basis points annually since 1975; and, as Zweig said, there's little evidence of a correlation between gross domestic product growth and stock-market performance.
It doesn't make much sense to argue with the data -- it is what it is -- but I differ with the conclusions drawn by Zweig and Heaton. Since the report was published in November 2005, the
iShares MSCI Emerging Markets Index Fund
(EEM) - Get Report
has risen 61%, while the
S&P 500 Index
of large U.S. stocks has fallen 2%, and the
iShares MSCI EAFE Index Fund
(EFA) - Get Report
of developed countries is up 0.5%.
Producers of such research compile a lot of data, which is used by investors to make decisions. Unfortunately, historical data doesn't take into account what's happening today. Understanding how markets have worked in the past is useful but insufficient for making a forward-looking analysis.
There's no way to know how many people invest in emerging markets because they believe GDP growth predicts stock-market performance. As I said to Zweig in my email reply, investing in foreign countries is about seeking diversification. That means looking for countries that have different economic attributes than the U.S. and, as a result, different stock-market cycles, giving investors a chance to reduce volatility.
For example, stock markets in Norway, Chile and Brazil peaked in the second quarter of 2008 versus October 2007 for the U.S. That means as the U.S. was headed lower, those three moved higher for another six to eight months.
The list of forward-looking reasons to invest in emerging markets is long: younger populations, improving living standards, ascending middle classes, better balance sheets and the fact that many of the countries produce things that the rest of the world needs. Put another way, many emerging markets are on firmer ground and are becoming more important in the world economic order. Those factors create a potential tailwind for stock prices.
Each country has risks: possible over-capacity in China, signs of overheating in Brazil, the earthquake in Chile has had lasting effects. The decision to own a market boils down to a weighing of the pluses and the minuses.
I'm always leery of arguments that are overly academic and overly reliant on the past. In my email exchange with Zweig, I noted that, based on results from the past 15 years or so, many emerging economies have dramatically outperformed developed markets. He's made a difficult argument, given that the fundamentals there appear to be improving and the fundamentals here appear to be getting worse.
At the time of publication, Roger Nusbaum had no positions in the securities mentioned.
Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. 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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