With the global economy headed for recession, debt crises brewing in Argentina and Turkey, and a potential military conflict looming in the Middle East, emerging markets might seem like the last place to look for investment opportunities.
Recent Meet the Streets
Indeed, while U.S. and European stock markets have rebounded from steep losses incurred in the wake of the terrorist attacks, emerging market indices have not.
But as long as you have an appetite for risk and a relatively long-term horizon, now may be the best time to scrounge for bargains, says Jeffrey C. Hooke, managing director of Hooke Associates, a corporate finance consulting firm, and author of a recent book entitled The Emerging Markets: A Practical Guide for Corporations, Lenders and Investors.
Currently, Hooke isn't actively managing money, but he does advise corporate clients on business and investing opportunities in emerging markets. Previously, he served as director of Emerging Markets Partnership, a $4 billion private equity partnership that specializes in the emerging markets of Latin America, Asia, Eastern Europe and Africa. He also was a principal investment officer in the Latin American Department of the International Finance Corporation, the private sector arm of the World Bank.
TSC: In past U.S. downturns, emerging markets have provided a great alternative to U.S. stocks. Why hasn't that been the case this time around?
Hooke: That was a myth. Basically, there were three myths that were perpetuated in the early 1990s about emerging markets. One, that they were countercyclical. The second was that corporate earnings were growing faster than the U.S. companies. The third was that the 25,000 listed securities across emerging markets provided more diversification.
What people found out was that they weren't countercyclical. They moved in sympathy with the United States. And while a lot of the GNP statistics were faster-growing, that didn't necessarily reflect faster corporate earnings, because a lot of these countries were heavily agriculture-based. Finally, while there is certainly more diversification in having more listed securities to select from, you can't easily invest in a lot of them because they just aren't liquid enough.
TSC: Are there any good reasons to invest in emerging markets right now?
In the 90's, the pendulum swung one way. The decade was characterized by a lot of hype and a lot of inexperienced people investing in emerging markets, so a classic bubble formed in the mid-1990s. There were a lot of foreign investors essentially chasing their tails, throwing money into these markets without any local buyers providing support.
When the foreign investors started pulling out, the markets essentially collapsed
because there never was much liquidity to begin with. A lot of emerging markets were trading at very high multiples at the time. People never really recognized the risks. So the collapse of the Asian Tigers and the Russian default screwed up a lot of people.
There was a dead cat bounce in these markets about 18 months ago, when people said, OK, now they're going to work through their problems. But it has become painfully obvious that there's no real impetus for financial reforms and debt restructuring. Many of the emerging economies are essentially treading water. That fact, combined with the U.S. economic slowdown, has lessened interest in emerging economies.
When the U.S. catches a cold, they
emerging economies get the flu. Now their economies are starting to slow down quite a bit. Combine that with the basic overlay of currency problems, financial instability, liquidity issues in the stock market and a general hangover from 1997 and 1998, and people are really looking at these markets in a negative fashion.
So now the pendulum has swung the other way. Now the reason you go in is that they're so beaten up. If you're in for a four- or five-year holding period, you can pick up some blue-chip stocks at a very reasonable cost relative to past history.
TSC: If there is no real desire to reform, isn't there a risk of further downside? Which countries have shown no desire to reform?
Oh, I'd say pretty much all of them. There's reforms going on but it's a very slow pace. We're looking at five, 10 or 20 years for things to really happen. So it's happening but it's really gradual. Short-term investors are going to be waiting a long time for fundamental reforms. But for speculative profits, there are some opportunities. Even if the economies aren't fully reformed or healthy, you can still make profits in some of these stocks, because emerging markets are a bit of a fashion item and they're going to come into fashion again at some point.
TSC: Are you worried about risk contagion in this environment? Is there a risk of default in Argentina and Turkey? And is there any possibility that we could see a repeat of what we saw in 1998?
There is a real risk of contagion, but it is far less than the risk that existed in 1998. I think if and when Argentina goes bankrupt, it's going to shake people up for a few weeks. But I think the market is pretty much mentally prepared for that possibility. I think the risks are much less than in 1998. If Argentina were to go bankrupt, I don't think there would be nearly the fallout we saw with Russia. You just wonder how much longer can the IMF constantly bail out these big economies.
TSC: Most emerging stock markets haven't recovered the losses in the wake of Sept. 11 like U.S. and European markets have. Why not?
Yes, well there's a bit of a flight to quality when something like this happens. Emerging markets really aren't quality. It's a bit like junk bonds. People dump junk bonds when times are bad, they do the same to emerging markets.
The other problem is they've changed the way companies are weighted in institutional indexes. Sometimes, in emerging markets, only a portion of a company's market capitalization actually trades. Where that company's weighting in global indices used to be based upon its market cap, it's now based on the market value of the shares that actually trade. That has hurt these companies.
TSC: You need to be a pretty speculative investor, someone with high-risk tolerance, to be investing in emerging markets now then, right?
Yes, you need to be a speculative investor, with high risk-tolerance and a longer than average time horizon. I'd say your time horizon has got to be at least three years. Let's say you're talking about a portfolio manager, or a hedge fund manager, with about $100 million -- he probably won't want to put more than $5 million to $6 million in emerging markets. That's the kind of allocation I would recommend -- 5% to 6%.
TSC: Where do you see values in emerging markets today? Where specifically would you recommend investors put their money?
I would look for companies that don't have very much debt. A lot of these big emerging markets corporations borrow a lot of money, and then on the downside they can't pay it back. And preferably, you'll look at companies that have some western influence on the management, like a joint-venture partnership, so that it's not really run like a family business.
TSC: What are your general expectations for emerging markets over the next five years?
Over a five-year period, I think it should largely match the U.S. market on a widely diversified basis. But because emerging markets are so volatile, I think there are pockets that should well outperform the U.S. markets by major margins.
TSC: Where are those pockets?
Some countries like Brazil, Malyasia perhaps, maybe Poland. Most investors tend to lump all the markets together,
but there are certain individual markets that can break from the crowd. In general, I think these have gotten pretty beat up with all the rest, and their macroeconomic circumstances are somewhat more favorable than other countries'.
TSC: Are any of the regions more favorable than others -- Latin America, Asia, Eastern Europe or Africa?
That's a tough question. I guess Eastern Europe, probably, because it's so close to Western Europe, which is their natural trading partner. Prices of securities are relatively low. I could see real integration taking place there over the next four or five years, whereas I don't see that happening in some of the other regions.
TSC: Are there any specific stocks you would recommend?
The Brazilian telephone stocks have been hit pretty bad. I like
. Both are cheap, well-positioned players in telephones and cable TV in Brazil.
is good equity play in Poland, though it's not an ADR (American depositary receipt).
Siam City Cement
has a joint venture with Swiss firm
is a good proxy for Malaysian recovery, while
is a solid company that will lead a South Korean comeback.
is an Indian growth company that's down over 60% this year, and is attractive at this level.