Every era comes to an end. We have believed for some time that the distinction between "developed" markets and "emerging" markets was becoming an anachronism -- one heavily embedded in allocation models and index methodologies, but blurring substantially around the edges.
We believe that yesterday's market panic over European solvency was as good a day as any to declare the end of the pure developed/emerging markets era of primary country distinction.
Before the current European credit crisis, key countries were changing in ways that made that basis of distinction less useful. Many of the "emerging" markets have been maturing in ways that bring them closer to the attributes that are the descriptors of "developed" markets; while some of the changes and events in the US have been more like something that would have been expected in an "emerging" market.
The big thing though is in the national financial accounts. We think a more useful distinction going forward will be between "solvent" countries and "insolvent" countries; and between "fast growing" and "slow growing" countries". You end up with Slow-Insolvent countries, Slow-Solvent countries, Fast-Insolvent Countries and Fast-Solvent countries.
"Big" and "small" markets will still be an important distinction in terms of their ability to handle large money flows, and therefore the rate of change of their market prices based on any fixed amount of money moving into or out of their markets, so maybe that needs to be a Z-dimension in the X-Y layout of countries by solvency and growth rates.
Capital used to flow from the developed to the emerging world, and that is probably still true for private capital, and may become more pronounced, but the capital flows at the governmental level seems to have reversed. Instead of the US bailing out Argentina, we have China bailing out the US. Instead of Russia and Thailand having a collapse of their currencies, the euro is collapsing.
The "developed" countries (let's not confuse that with "wise" or "well managed") are in deep financial doo-doo -- having spent themselves and committed themselves well beyond their means. Their governments have bailed out their citizens and their industries. Now smaller countries are being bailed out by larger country groups and supra-national organizations. Who will bail out the larger country groups and supra-nationals? -- the Chinese? -- we don't think so.
The resolution of insolvency and spending profligacy can only be deferred, repackaged, passed along for so long before somebody somewhere has to take the hit. Slow-Insolvent countries will take the hit before the Fast ones, be they Solvent or Insolvent; and before the Solvent ones, be they Slow or Fast.
We don't have a perfect idea here, of course, but do believe that solvency (probably in association with economic growth rates and total size) is a better way to look at countries these days -- that's generally how investors look at companies, and countries to investors are basically just great big conglomerate companies.
Disclosure: There are no securities named in this article.
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