Investment Strategies: Latin America and Asia

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 |  Includes: ADRE, EEM, EPP, EWY, EWZ, EZA, ILF
by: Elliott R. Morss

Introduction

I am struck by how the investment pundits can generate new recommendations on a daily/weekly basis. Except at times of panic like the collapse of Western banks in late-2008, economic conditions change slowly.

And good economic thinking is rare. For example, in a recent posting, the best economic advice I could think of for what governments should do in today’s global recession was contained in a letter from John Maynard Keynes to FDR in 1938.

Where is the world now? There are two answers to this question. Western nations remain mired in the recession – for example, the US is still losing jobs net – in February, 35,000 jobs were lost and over the last 3 months, 171,000 jobs have been lost. And Western government debt is growing rapidly as deficit finance is being applied to stimulate economic activity.

In developing countries, things are quite different; after temporary setbacks caused by a reduction in Western demand for their exports, developing countries are growing again, with the growth fueled primarily by their own middle classes.

Past Investment Suggestions

Three quarters ago (June 2009), I recommended betting against the dollar by investing in developing country stocks and commodities. My stock picks are summarized in Table 1, with the S&P 500 included as a frame of reference.

Table 1. – Stock Market Performance

* ETF - Exchange Traded Fund, M – Mutual Fund

Stock Market Correlation

After all my arguments for betting against the dollar, investing in emerging nations, etc., my stock picks since June 11, 2009 have performed only marginally better than the S&P 500 (23.7% vs. 21.3%). Many would argue this is because global stock market movements are so highly correlated.

Certainly in the past, this has been true at least for emerging stock markets. Why? Because a very significant portion of investors came from Western countries. Anytime, they got scared, like when the Western banks collapsed in late 2008, they liquidated all their stock holdings, both in their home countries and in emerging markets.

My argument is that while this correlation has held in the past, it will break down in coming years for the following reasons:

  • The fundamental economic conditions of developed and emerging market countries are so different;
  • A growing awareness of these differences in both Western and Emerging Market countries.

Fundamental Economic Conditions

Here, I will be very specific. Because of fundamental economic conditions, my investments are in Brazil, China, India, South Korea, South Africa, and a Latin American mutual fund. Table 2 provides in summary form the differences in both projected growth rates and debt between Western nations and emerging markets.

Table 2. - Economic Conditions

GDP Growth (%)

Debt

Ext. Debt

Govt. Debt

Actual

Projections

% GDP

(% GDP)

(% GDP)

Region/Country

2008

2009

2010

2011

2010

2009

2009

World output

3.4

0.5

3.0

4.3

Advanced economies

1.0

-2.0

1.1

2.4

333

9.1

0.7

United States

1.1

-1.6

1.6

2.4

290

13.5

0.4

Euro area

1.0

-2.0

0.2

1.6

Japan

-0.3

-2.6

0.6

2.2

459

4.1

1.9

Emerging Economies

6.3

3.3

5.0

6.3

Sub-Saharan Africa

5.2

3.4

4.9

5.5

Low

low

low

China

9.0

6.7

8.0

9.7

159

0.6

0.2

India

7.3

5.1

6.5

7.8

129

1.5

0.6

South Korea

2.2

-1.8

2.5

3.7

331

0.9

0.3

Latin America

4.6

1.1

3.0

3.8

142

1.1

0.4

Brazil

5.8

1.8

3.5

3.7

142

1.4

0.5

Click to enlarge

Source: IMF, World Bank

Advanced economies are projected to grow at a 1.1% rate in 2010 and at 2.4% the following year. Emerging economies are projected to grow at 5.0% in 2010 and 6.3% in 2011. Differences in debt levels are similarly striking.

The US Dollar

The US trade deficit is now running just over $500 billion annually, down from over $600 billion in earlier years. As indicated in earlier postings, much of this has been absorbed by China and Japan purchases of US government debt. We hear that neither country is eager to continue purchases as past rates.

But there is another point of significance here – foreigners purchases of US equities and Americans purchases of foreign stocks. Foreign purchases of US equities are like a US exports: it reduces the global supply of dollars and makes it stronger. US purchases of foreign equities are just the opposite: it increases the global supply of dollars and makes it weaker.

In both 2006 and 2007, foreigners purchased $1.6 trillion in US stocks and bonds. In those same years, Americans bought $1.3 trillion and $1.5 trillion in foreign stocks and bonds, respectively. In light of the different economic conditions in the US and emerging market countries, do you think foreigners will be as eager to buy US equities as they have in the past? And equally important, won’t Americans want to buy more emerging market securities. Both actions should weaken the dollar.

Investments

In light of the above considerations, my portfolio holdings are listed in Table 3. I am betting against the dollar with investments in countries with good growth prospects and little debt. How sure am I that my arguments will prove correct? Not very – a random walk….

Table 3. – Morss Portfolio

Returns

Investment

Vehicle

Ticker

1 Yr

3 Yr

iShares MSCI Brazil Index

ETF

EWZ

121.50%

20.89%

iShares MSCI South Korea Index

ETF

EWY

71.72%

-0.11%

T. Rowe Price Latin America

M

PRLAX

96.77%

7.51%

iShares MSCI South Africa Index

ETZ

EZA

51.23%

2.74%

Matthews China

M

MCHFX

78.84%

11.79%

Matthews India

M

MINDX

113.99%

5.32%

Click to enlarge

I am not an investment adviser and nothing I say should be taken as a recommendation to buy or sell an asset.

Disclosure: Author holds long positions in EWZ, EWY, PRLAX, EZA, MCHFX and MINDX