Never Mind the Positives

06/11/2009 1:57 pm EST

Focus: GLOBAL

Igor Greenwald

Chief Investment Strategist, MLP Profits

The Nikkei 225 has just busted through to an eight-month high, Indian stocks are significantly higher than they were after that 17% post-election surge two weeks ago, and Hong Kong erased a week's worth of profit-taking with Wednesday's 4% pop.

But who gives a lat about that old song? Instead, in the ambulance-chasing tradition suiting journalism's current straits and disposition, let's ponder what else could go wrong.

Ideally, the bad-news scenario would incorporate a real-life riches-to-rags protagonist, for readers to pity over the fateful choices made and the warning signs ignored. This is hard to pull off on a global scale with France not rioting, China far from starving, and even dear old England showing faint signs of life (though not enough to send Gordon Brown back to Scotland—yet).

Fortunately for multinational doomsayers, there's Latvia. The Baltic upstart really lived it up and now can't pay the tab. It's Iceland without the fjords, a Stockton with less crime and better shops.

Rapid growth after the fall of Communism and the eventual currency peg to the euro lured hot money from all over the world, rapidly inflating the notional worth of Latvia's 2.4 million inhabitants and drawing even hotter money, until the bubble burst. Now the economy is shrinking at more than 10% annually and there's no stimulus; the International Monetary Fund and the European Union are instead demanding deep across-the-board cuts in public spending, while the currency peg has become an economic millstone, subjecting Latvia to capital flight for fear of an imminent devaluation.

From there, the unraveling thread leads to neighboring Lithuania to Estonia, as well as to the heavily exposed Swedish banks, whose looming losses have already led the Swedish central bank to secure an EU credit line, just in case. From there, it's just a hop and a skip to Ireland, which recently saw its credit rating downgraded, and to the UK, which faces the same unappetizing prospect. And then there's the biggest debtor of them all—the US—its rising borrowing costs a daily disappointment to the bulls on Wall Street.

The same consensus that consistently dismissed this spring's revival is now counting on higher commodity prices and interest rates to throttle consumers before they can find jobs. Debt has become a four-letter word, the very notion trashed regularly by critics who stress the incriminating evidence of the last couple of years at the expense of the broad sweep of human history, during which debt--including government borrowing—accomplished a few things of note.

But for every Latvian and American knee-deep in bills, there's more than one Asian and Latin American with savings to spend and to invest, and little of the leverage we now scorn. If they're not buying US Treasury notes, it might be because they have better options closer to home.

For a clue as to what these might be, consider the price of emerging-market small caps. One proxy, the WisdomTree Emerging Markets SmallCap Dividend Index, which underpins a similarly named ETF (NYSE: DGS), currently sells for 1.3 times book, seven times cash flow, and ten times earnings, with a 6% dividend yield. Even without factoring in the geographic diversification or the dollar hedge, that's a lot more bang for the buck than the bank down the street can offer.

There are still bargains in developed markets, too, and our sources highlight two this  week, with Allan Nichols receptive to the recessionary advantages of BSkyB, while Tom Slee was on board for the recent rally in North American railroad stocks. Still, incremental growth and therefore incremental commodity demand depends crucially on emerging-market consumers, writes Prieur du Plessis.

In an interview last month, the South African investment manager recommended South African retailer Foschini , which happens to be a key component of the DGS by virtue of a yield above 5%. The company has been around for 84 years, and shows no sign of succumbing to the consumer fatigue in distant North America.

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