Emerging Markets—for the Long Run

01/19/2009 9:54 am EST

Focus: GLOBAL

Chris Gilchrist

Editor, The IRS Report

Chris Gilchrist, editorial director of Everyinvestor, sees a return to emerging markets—on a much saner level.

The emerging economies will keep on growing through the 2009 recession, and their savings will finance the eventual recovery. But does it still make sense to invest there?

The great investment story of the new millennium has been the emerging economies. Led by China, India, Brazil, and Russia, they’ve seen economic growth rates soar to 6% to 10%.

Hundreds of millions of people have moved from dollar-a-day subsistence to what qualifies as middle-class in these poor countries: a steady job, a home, clean water, the ability to pay for school fees and medicines… and dream about owning a car.

From 2000 to 2008, it seemed a tidal wave of prosperity was spreading across the world, and funds investing in these countries produced stellar results. Between January 2004 and January 2008, the average global emerging market fund turned £1,000 into £2,500, while a UK investor was lucky to get £1,500.

But since the credit crunch struck, the picture has changed. At first, analysts hoped that emerging markets would escape the effects, since they had no banking or debt bubbles. In most emerging economies, savings rates are high—as much as 30% of incomes—and there’s little if any mortgage or consumer debt. But that hasn’t stopped their financial markets seizing up and melting down.

Two things have happened to send markets into a tailspin, with overall declines in stock markets now reaching 50% to 60%. First, it’s become clear that exports from emerging economies are shrinking fast as the recession bites in the US and Europe.

Then in October, in an even more scary development, share prices plunged in all the emerging markets as banks forced investors who’d borrowed to finance their investments to repay their debts.

Hedge funds, under the [gun] for poor performance, saw investors withdrawing record amounts of cash, forcing the funds to sell off more investments and driving prices down further. Over the past 12 months, emerging markets are down an average of 45% compared with declines of 35% for the UK and a mere 20% for Japan.

Shell-shocked fund managers aren’t convinced the bloodbath is over. They know that even though the banking systems in these countries are mostly sound and that countries like China, India, Russia, and others have vast foreign reserves to support their economies, the markets are now in the grip of a panic and there’s no knowing when it will end.

That said, you can also be confident that these emerging economies will continue to grow much faster than the developed world. Even next year, China and India will record 6% to 7% GDP growth. And just as giant steel, car, and banking firms emerged from the growth of the US economy, over the next decade, the emerging economies will create their own “blue chips” like Sony, Toyota, and Samsung.

So there is still a strong case for investing in emerging markets if your time scale is a decade or more.

I wouldn’t advocate making a lump sum investment at the moment. But I do believe that emerging market funds should be part of any long-term regular savings plan.

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