Emerging markets have always been a popular destination for American investors, especially in times of record low interest rates and slow growth at home. This can explain why US investors are flocking into emerging equity markets, pouring money into Brazilian and Peruvian mines, Russian energy companies, and Chinese bank IPOs, driving the Emerging Markets Index (EEM), and companies like Vale Sa (VALE), BHP Billiton (BHP) Petrobras (PBR), YPF and Sina Corporation (SINA) sharply higher.
The trouble, however, is that emerging market investors are exposed to events that may magnify traditional investment risks. One of these risks is the prospect of a substantial slow-down in the world economy that may take its toll on emerging market economies, especially those depending heavily on exports. Another risk is the rise of proactive government regimes that may limit or even reverse globalization. A third risk is the outright nationalization of foreign entities.
Anyone following the world economy recently cannot help but identify signs of all three events:
- According to World Trade Organization, the world economy has been slowing substantially lately. Trade expanded in 2011 by 5.0%, a sharp decline from the 2010 rebound of 13.8%, and growth is expected to slow further still to 3.7% in 2012, due to a number of shocks, including the European sovereign debt crisis, oil disruptions, and the Arab spring.
- Extreme political ideologies are on the rise in Europe-Greek communists are expected to win 35 percent of the popular vote in the upcoming May 6 elections; and an extreme right wing party is expected to enter the Greek Parliament for first time since 1980s.
- The Argentinean government is contemplating of nationalizing YPF, which is controlled by Spanish Repsol (REPYY.PK).
The bottom line: Emerging markets investing isn't the same as investing at home. Investors should weigh carefully the risks and rewards of buying assets away from home, and they may consider investing in companies that are well-diversified around the globe like Coca-Cola (KO), McDonald's (MCD) and Yum! Brands (YUM).
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.