Thursday, October 15, 2009

Emerging Markets: More in line with the US market than first meets the eye

I buy into the idea that the greatest opportunity for growth in the future will be outside the US. Even more immediately, I will show in this post that the decline of the dollar will make smart emerging market investments even more attractive in the coming deflationary correction.

For example, let's refer to recent history regarding the behavior of the market during the crisis days of Nov 2008. At that time there was a tremendous flight to the USD dollar as investors sought safe investments during the crisis. During that time, the Brazilian Real lost 50% of it's value due to declining commodity purchases and concerns over the world economy.

One of the investments I find attractive in South America is Brazilian bank Banco Bradesco (BBD). I expect that banks will profit from the emergence of a new middle class in Brazil. BBD was trading at $10 in November. As of today the stock closed at $21.50, clearly outpacing the market as a whole. But this is not so simple, because since November the Brazilian Real has recovered 40%, the stock has only appreciated 60% in local currency. This only slightly outperforms the 53% returns of the S&P 500 index from March 2009 bottom. This is occurring not just for Brazil, but for Mexico and many other markets where currency appreciation has occurred against the USD. Many investment magazines and pundits have been pumping emerging markets as outperforming the US. Actually, performance is equivalent, it is just the currency basis that provides the advantage.

What do we gain from this observation?

1) When panic strikes, and there is a flight to the USD, emerging market companies become very cheap

2) If the US, in response to a panic, uses easing methods to address the downturn, this is bullish to US investors interested emerging market stocks simply because of the basis risk (or in this case reward) from monetary easing and a devaluing USD.

I have no positions to recommend at this time. But it is easy to foresee another stage in the crisis due to deflation that is addressed once again with huge floods of dollars. At that point, it will be important to recognize this pattern and take positions in companies like BBD, CETV, TLK, SBS, and GMK to reap benefits from this occasion.

1 comment:


Great post on emerging markets.