Emerging Markets: To Invest or Not?

08/25/2006 12:00 am EST

Focus:

James Stack

President, Stack Financial Management

In this missive to his subscribers, James Stack analyzes up-and-coming markets outside those of developed countries. And he answers the question looming in the minds of investors worldwide: Is it time to begin investing in emerging markets?

 

“The original G-7 nations have historically meant safer, more stable investing returns, while “emerging markets” were considered speculative. As these fast-growing developing economies approach their G-7 counterparts in size, does it mean investors can view them with the same assurance of stability? Not really…or at least not enough to make us alter our strategy when investing in these markets. When looking at the six largest emerging economies (China, Brazil, South Korea, India, Mexico, and Russia), following are some of the investing pitfalls that persist regardless of their improved economic status.

 

Stock Market Limitations. Stock markets are growing quickly. The size of China’s stock market has increased 177% in the past year, while Russia’s has doubled. Still, these markets are small in comparison with the developed market exchanges. South Korea has the largest market by capitalization at nearly $700 billion, but the three US exchanges combined total $17.5 trillion. Many listings are small companies with illiquid stocks. Only a tiny handful have managed to meet the strict requirements needed for listing in the US.

 

Government Intervention. In some markets, particularly more progressive Communist countries, governments maintain significant ownership or control of enterprises. In China, the government has started to privatize companies and sell off some of its shares, but it still owns the majority of stock in large companies. Offsetting this trend, the Financial Times reports that the influence of the Communist party is still present in many private companies where it has set up committees that allow access to state-controlled loans and raw materials. Russia, under Putin, has actually increased government control in lucrative industries—particularly its huge oil and gas resources. The takeover of the Yukos oil production division in 2004, allegedly for tax violations, was an eye opener.

 

Lax Regulatory Standards. Although they are improving, foreign markets vary widely in their regulatory standards, and no emerging market comes under the scrutiny we’re used to in the US or other major G-7 markets. Moreover, “transparency” is often not to be found. Accounting standards are lax, financial reports may show up semiannually (if at all), and disclosures are considered optional.

 

"Obviously, these six largest emerging markets are more developed than they were at the time of the Asian Financial Crisis in 1997. They are at the forefront of global economic growth and are frequently in the headlines. Although there’s pressure to include at least some of them in the G-8, the verdict is "no" for now."

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