Look at Re-Emerging Markets

08/25/2008 12:00 am EST

Focus: GLOBAL

Paul Goodwin

Emerging Markets Specialist and Analyst, Cabot Heritage Corporation

Paul Goodwin, editor of Cabot China & Emerging Markets Report, thinks there may be bargains in the battered emerging markets.

Q. Emerging markets have been beaten up and the Russia/Georgia conflict, unfortunately, points out one of the problems with investing internationally-the uncertainty of government and political actions. How can investors protect their portfolios?

A. Every investor should follow the usual advice-diversify your portfolio among different asset classes, including bonds, value stocks, income stocks, and growth stocks. Avoid overexposure to any one sector or industry, no matter how hot. 

But we follow two additional important rules: 1) Use a strict loss limit of 15% (in difficult markets) or 20% (in supportive markets); and 2) always be prepared to exit the equity markets and go to cash when the general trend of the market is against you. 

Q. What is your opinion on investing in frontier markets?

A. Frontier markets can turn in tempting results, but we prefer the risk-controlling effects of investing only in stocks that trade on US exchanges as ADRs, which must meet the exchange reporting standards. We don't rule out the possibility of investing in a particular frontier-market stock, but collective investing in frontier mutual funds, derivatives, or index funds is the equivalent of rolling the dice.

Q. Should investors look at global investing from a top-down approach or should they be more concerned with the company's fundamentals, and pay less attention to the macro factors?

A. We use a SNaC approach to stocks-equities that have excellent stories (S), supportive fundamental numbers (N) and technically strong charts (C). Demanding strength in all three mandates a bottom-up, stock-by-stock approach, regardless of country.

Q. What percentage of their portfolios would you recommend that investors allocate to global issues?

A. There are no blanket allocation rules that work for everyone, and investors should discuss portfolio construction with their financial advisors. With that said, however, we think it's appropriate for a properly diversified portfolio to allocate up to 10% of its equity component to emerging market stocks.

Q. Would you share a couple of your favorite emerging markets investments?

A. I think China's Sohu.com (Nasdaq: SOHU) is a very strong company with great earnings (up 410% year-over-year in Q2) and a dominant position in the Chinese Internet world. Sohu offers a sticky confection of news, games, and a dozens of specialized group sites that keep users online (and clicking on ads). Once China emerges from its recent swoon, SOHU will be an attractive proposition.

I think Brazil's Gafisa (NYSE: GFA), a national homebuilder, will be a winner when the country emerges from its interest-rate tightening cycle. Demand for housing is high in Brazil, and Gafisa's large inventory of land suitable for development is among the nation's largest. It may take some time for the Brazilian market to get back onto a growth wave, but when it does, Gafisa will be a big winner.

Q. Emerging markets have performed dismally amid rapidly rising inflation and a slowdown in developed countries' economies. Do you think the story is over for at least the next couple of years?

A. One of our most important rules is to resist the temptation to try to predict the future.  But with all that said, one major truism that individual investors always forget is that markets bottom when the news is worst. By definition, the moment the last discouraged investor finally gives up and sells his last stock is the moment the market begins to turn up. I don't know when that will happen, or if it has already happened, but I can read the numbers that show how steeply both emerging and developed markets have already corrected. This is exactly the kind of discouraging, hope-squashing environment that provides the seed bed for the bright future.

Subscribe to Cabot China and Emerging Markets Report here.

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