U.S. Stocks Have Potential to Dominate Global Markets Post-2008

By Eric Roseman

Since 1998, the Morgan Stanley Capital International [MSCI] Emerging Markets Index has gained 13.5% per annum or 9.5% annually adjusted for inflation. That's the highest total return posted by any broad global index over the last decade. This one number flat-out confirms that major markets have lagged behind emerging markets.

Indeed, emerging markets continue to post strong growth rates while the industrialized economies continue to struggle. Markets from the U.S. to the Eurozone are drowning under debt deflation tied to a financial crisis, rising long-term unemployment and declining standards of living.

The emergence of China as a major financial power combined with rich commodity-producing nations of Brazil, Russia and the Gulf States all point to a bright long-term outlook for emerging market plays.

It's worth noting that emerging nations hit a bear-market low in late 1998 following the Asian economic crisis and the Russian ruble collapse.

At the time, this marked the best market-timing purchase among select global indices. We may see the same opportunity emerging here in the U.S. in the S&P 500.

For now, the S&P 500 Index remains hostage to a credit squeeze, deflation in housing, and a decline in domestic consumption. But that may all change soon.

Amid a 13-month credit crisis affecting most of the developed world, the United States might be at the cusp of outpacing other markets over the next decade. What happened in the emerging markets 10 years ago suggests this might be possible, at least from a contrarian investor's standpoint.

Developed Markets in the Doghouse for the Last Decade

Anyone who loaded up on major industrialized markets since 1998 has earned poor returns in nominal terms and negative results adjusted for inflation. U.S., European and Japanese equities have ranked as some of the worst investments over the last 10 years in dollar terms as two bear markets, including the current credit crisis, deflates long-term returns.

Emerging markets, however, have earned impressive inflation-adjusted returns over the last decade and have protected investors from inflation.

Indexing, unfortunately, has done a poor job over the last 10 years for major market investors.

Major markets are defined by the MSCI World Index, created in 1969. These include the United States (48%), Canada, Europe, Japan, Hong Kong, Singapore, Australia and New Zealand.

Since 1998, the MSCI World Index has gained just 2.7% per annum. That return trails not only T-bills over the same period but also inflation. That strands investors with a negative real return of about -1.3% per annum.

That's hardly impressive.

What's even more depressing is the fact that those returns include the benefits of dollar depreciation vis-à-vis foreign currencies in the index, or 52% of the World Index. A plunging dollar didn't help results, either.

If global investing isn't your thing, staying at home didn't boost your portfolio, either.

Home-Grown Investors Watch Their Portfolios Crash and Burn

Since 1998, the S&P 500 Index has rallied only 2.5% per annum. Adjusted for 4% annual inflation over the same period, investors have actually lost 1.5% per year over the last decade.

The only broad global indexes to post solid inflation-beating returns since 1998 are the emerging markets.

Emerging Markets Rise from the Ashes

In 1998, Russia's economy collapsed. The Russian government defaulted on its foreign debt obligations while the ruble went into a freefall.

In Asia, regional governments exhausted their central bank reserves defending overvalued currencies. This all led to the destruction of credit that began the summer of 1997.

This was exactly the time to aggressively buy emerging markets, and eventually, commodities. Oil prices bottomed north of US$10 a barrel in late 1998.

As we all know, this story changed quickly. Aided by rising prices for commodities, emerging markets went on to post the most impressive gains in the last 10 years. And it's not surprising.

After all, the emerging markets are home to the world's fastest-growing economies supported by bulging trade surpluses, booming foreign-exchange reserves and in most cases, healthy balance sheets.

There's no doubt that in the longer term, emerging markets will become larger and therefore dominate global stock market performance. Growth rates will certainly continue to outpace the major markets for years to come. But a marked slowdown in exports and a prolonged commodity slump might also crimp the near-term prospects for emerging markets.

It is possible that after years of huge triple-digit gains the emerging markets can lag the major markets. That's especially the case after the crippling declines we've seen in the financial stocks. A recovery, however short-lived, will boost the value of U.S. equities because financials comprise more than 15% of the broader market and more than 20% across Europe.

Financials Will Dominate

History strongly suggests that financials will eventually form a bottom and lead another broad rally for major market equities.

It might be hard to make a long-term case for financial services as industry business models have radically changed and have been compromised by the credit squeeze. Still, a major advance in emerging markets can happen even for a short period of time.

I'm certainly not long-term bullish on U.S. or European stock markets. The smart money will remain committed to emerging markets, including new frontier markets like Vietnam, Bangladesh, and Botswana among others. Plus, China, India, and Brazil are superb growth stories for the next 10 years.

But it might be time to start looking carefully again at U.S. stocks as foreigners return to positions that have been severely slumped over the last few years. A stable dollar would go a long way in solidifying this possibility.

Stock position: None.

Comments

[buyitcheap:]

I like them - 20%-40% lower, which is where they will be shortly.

2008 Sep 16 09:11 AM