Emerging Markets A Safer Haven?

By Murray Coleman

Economists still are bracing for a slowdown in the U.S. during the second half of 2008. But some analysts say they're optimistic about prospects next year. Whether that happens or not, several countries figure to withstand a slump in western economies better in the meantime.

Should that impact your investing? As Larry Swedroe points out in an ongoing debate on IU's discussion board, correlations between gross domestic product and stock markets are murky at best.

He contends, in fact, that they're negatively correlated.

Maybe so. But it's also true that economic data started suggesting a widespread downturn in the flow of investment capital and purchasing of goods and services in many segments early last year. Primarily, that was coming from financial-services-related areas.

Sure enough, it was just a matter of time before financial stocks felt an impact. Although it was delayed until late summer, and the severity unexpected due to a meltdown in mortgage-backed securities, markets were weakened.

"The probability we're in a recession right now is almost 100%," said Virendra Singh, a Moody's economist. "All of the problems of the financial markets are definitely leaking into the stock markets."

But one reason for optimism, according to Singh, is that policy makers finally seem serious about taking action. He pointed to U.S. Treasury Secretary Henry Paulson's proposal to scrutinize lending practices more closely made public in a speech on Thursday. Earlier in the week, a Fed move to shore up banks' sagging fortunes by providing some short-term liquidity relief also was greeted with cheer on Wall Street.

"The Federal Reserve is becoming much more aggressive about lubricating the financial markets, which are all gummed up," Singh said. "The Fed and the U.S. government are moving in the right direction now."

And a tax rebate coming in May should also help anemic consumer spending, he added. "That's very important because over 70% of GDP comes from consumption," Singh noted.

As a result, Moody's economists are optimistic that even though the third and fourth quarters look rough this year, in early 2009 the U.S. economy should be ready to move ahead.

The problem for investors, of course, is predicting when and how deep such macro trends will be felt by financial markets. If you've got the luxury to plan long term, then a mild recession probably isn't anything to get worked up about.

But if you're on a fixed income and can't afford to lose much in the interim, consider that economists like the prospects for eastern Asia. "China will take a small hit, but not as big as the U.S. and other parts of the world," Singh said, noting he's not speculating on markets but broad economic data.

Here's where the tricky part comes. So far, that hasn't been the case. Take the mega-cap iShares FTSE/Xinhua China 25 Index (NYSE: FXI). It's down more than 19% this year, more than double The SPDRs (AMEX: SPY).

But economists and stock traders seem to be in agreement about many Latin American markets. The SPDR S&P Emerging Latin America (AMEX: GML), for example, is up more than 3% in 2008.

Longer term, economists also continue to favor prospects for larger developing countries such as Brazil, China and India.

"We maintain that despite the U.S. recession, as well as a slowdown across developed markets such as the U.K, euro zone, Japan and Australia, the world economy will continue to grow," said Matthew Cairns, a senior Moody's economist, in a recent report.

In the short term, that should support expansion of local economies in countries like Brazil and Indonesia. The iShares MSCI Brazil Index ETF (NYSE: EWZ) is up slightly this year. The iShares MSCI Chile Index (NYSE: ECH) is doing even better with a 6%-plus rise so far.

But even Mexico is seen as emerging from the U.S.' shadow. The iShares MSCI Mexico Index (NYSE: EWW) has gained more than 2% this year. Elsewhere, the iShares MSCI Taiwan Index (NYSE: EWT) is also in the black. And keep an eye on Russia's expanding influence over emerging markets in Europe. According to Moody's analysts, the country's using its dominance in European energy markets to manipulate political developments.

"Furthermore, the move toward ‘market pricing' by Russia's energy producers has significant implications for economic growth. Gas charges to Ukrainian consumers jumped a massive 38% at the beginning of the year - a development that is sure to dampen consumer spending and ease growth further," wrote a team of Moody's economists.

Also, if you're thinking about changing around your portfolio to protect against a declining dollar, be forewarned that not everyone's in panic mode yet.

A foreign currency ETF or two probably won't hurt. But some perspective might be needed if you're long-term oriented. In a nutshell, Cairns in another study concluded that the situation isn't as dire as many are claiming.

"Because central banks in the Middle East and Asia would book huge losses if they sold out of dollars, the likelihood of their doing so is slim," he wrote. "Moreover, further weakening of the dollar means the competitiveness of many Russian, Middle Eastern and Chinese exporting segments will decrease."

Cairns added: "Their respective export performances over the past several years are helping them accumulate these vast reserves. Biting the hand that fed them does not seem their best option at this stage."