Perhaps you remember the "decoupling" theory from earlier in this decade; the idea that emerging markets [EM] might produce returns not correlated with developed markets [DM]. Early in 2008, when equities were declining everywhere, analysts began to debunk this idea, and reasserted the thesis that our interconnected economies would force EMs into following the DM cycles. The crash last summer and fall seemed to settle the matter in favor of the one-world school.
But things have changed. In the first quarter of 2009, while US equities were -12% and the rest f the DM -15% [all numbers from MSCI indices], EMs were only -1%.
This -1%, however, covers an even wider disparity between different regions. Eastern Europe (ex-Russia) is the bear of the season, -28%, while the Bull lives in Shanghai, +28%; with franchises in Chile and Brazil at +14 and +10; Taiwan, +8; Russia (ADRs) +9 -- and if you were Contrarian enough to invest in Pakistan in January, you would now be boasting gains of +40% (from Jan 1; double that from the middle of the month)!
[Note: ONLY the Shanghai shares of Chinese companies are up; the H-shares and ADRs are flat to slightly down YTD. For Russia, it's the reverse. Explaining this is beyond my pay grade].
Of course, our perception of these gains may shift when we look at a bigger picture. On a six-month chart, the EAFE index never deviates from the $SPX by more than a few percentage points. Brazil ends up in exactly the same place (-30% from 10/1/08), although she got there by way of a much deeper dip; so the YTD improvement simply reflects the indisposition of the Bovespa at the turn of the year. But China's performance looks even better on this scale: -19% over the same 6 months; while Chile outperforms all: -12%.
Inquiring minds will want to know why some markets perform so much better than others.
Answers vary, but one theme often cited is fiscal discipline. While the US and Europe played with leverage, most EMs were innocent of such ploys and just went on making money by actually producing things. China and Chile, among others, have been particularly fastidious about banking their profits in sovereign funds, to protect against the downside. These countries are able to continue spending on domestic needs despite the current crimp in exports.
Much has been made of China's economic slowdown. Exports have fallen by something like 40%, so the Chinese government must be lying about their current growth, according to some. Anecdotes of newly-built cities left nearly empty by the downturn argue that the economy must be shrinking. This ignores the size and complexity of China. Perhaps 2 or 3 provinces have gone from boom to bust in the export business, but how much are other parts of the country affected? (How much did Detroit care when the Tech bubble burst? How much does Silicon Valley care if GM goes bankrupt?) The answer is, we don't know. I believe it is effective to make a distinction between the sectors that are slumping from the decrease in exports, the ones that are booming from new investment in infrastructure, and those that are just getting along in between. This is where you would think a good fund manager could be brilliant; but from what I can see, most big funds are still in the same big companies they got rich on in 2007.
There are cases to be made for other EM regions, of course. Israel has a strong market (pharmaceuticals and tech) and is an increasingly popular investment destination. Perhaps India, Russia, Turkey, Mexico, or (fill in the blank) is actually bottoming now, and wouldn't it be great to get in at the bottom? South Africa, Australia and Canada will be booming from the demand for hard assets (gold, base metals, oil) as inflation sets in throughout the over-developed world. New Zealand will thrive with agricultural resources when the rest of the world is shriveling up from global warming. Pick your thesis and open the atlas. There's always a bull market somewhere.
Of course, this is not to recommend wanton recklessness. Not all decoupling is to the upside. But there are great possibilities for those who can discern where, and when, to find them.
Disclosure: the author has long positions in EWZ, ECH, SQM, TSP, HAO, SOHU, LUKOY, and a handful of small-cap Asian stocks.