Baseball, Apple Pie And Emerging Market Bonds

by: Jeff S. Vollmer

As a child, I was spoiled. Rotten.

By the time I was seven, my expectations had become so elevated that disappointment was imminent. Eventually, the harsh light of reality crept over the horizon. Once in view, I saw the light. And was crushed.

You see, I was a baseball fan from day one. The Reds had me at Hello. And having been born in 1969, I was indoctrinated at the onset of one of the greatest teams in baseball history: The Big Red Machine.

I sat on the old man's lap and watched my first game, chomping nervously on my pacifier, warm milk in hand. Ended up getting so nervous that I drank too much and wet my pants. Sorry dad. But I wasn't embarrassed. I was obsessed!

How could you not be? Under Sparky Anderson's leadership, The Reds won NL Pennants in 1970, 1972, 1975 and 1976. They went to the World Series in 1972, 1975 and 1976. They won it all in 1975 and 1976, becoming the fist team since the '21 and '22 New York Giants to win consecutive World Championship Series.

Johnny Bench, Pete Rose and Joe Morgan each won NL MVP honors during that run. In fact, Rose was the only one who didn't win twice.

During the playoffs, I would sprint home after Maple Dale Elementary's final bell to watch my beloved Reds battle the Pirates, Dodgers and Cardinals. Could've taken the bus. But it was too slow. Every inning counted.

Well, the Reds made one last run at the NLCS, unsuccessfully, in 1979. By 1980, The Big Red Machine looked more like a vending machine. Its best players scattered to the wind.

The next 10 years? A long walk through the desert. Following the success with which I'd been confronted at so tender an age, those 10 years seemed like 10,000.

"Dad, are you telling me that the Reds don't go to the World Series every other year? And what in the heck is Pete Rose doing in Philadelphia?!"

Point is, cycles end. Rotations turn and favor yesterday's weakest links, much to the chagrin of those appalled spectators who assumed that success was everlasting.

Economies and the investments therein are no different. Yesterday's world champions are tomorrow's limping losers.

From 1978 through 1999, the S&P 500 index was negative in only two years. Otherwise, investors in large cap U.S. equities kicked butt and took names. Lots of them.

Then, from 2000 through 2002, they did not. Yet, other areas of the market did great. If you weren't tied down to one team.

Point is, as in life, success -- and a lack thereof -- occurs cyclically. In a rotation. Losers become winners. When I grew up, the New England Patriots were terrible. Laughingstocks. Look who's laughing now. Certainly not their poster boy quarterback, who also happens to be married to the world's most highly paid (and reasonably attractive) Brazilian super model.

Five years ago, the very mention of emerging market debt was enough to make the drunkest of speculators risk averse. Emerging market nations were poor. And poorly run. Why invest in foreign bonds that could be more volatile than domestic equities, right?

Rotation shifts. That's why. Even dark horses leave the barn.

As U.S. earnings as a percentage of GDP reach their highest levels since 1929, and wages as a percentage of GDP reach their lowest since 1937, you simply can't help but look elsewhere. U.S. Treasuries? Two percent returns. European equity? Don't even go there.

So what about those emerging markets? What, with their burgeoning middle classes, sparkling infrastructure and thirst for success? They're like the Dos Equis guy, with higher yields.

Don't simply consider emerging markets equities. Consider their bonds. Less volatility. Lots of upside.

EM bonds provide 3% to 4% more yield than their U.S. counterparts. Moreover, consider their debt to GDP ratios? Very American, when America was debt free.

The G-5 -- the world's five largest economies -- comprise 40% of world GDP, but hold 70% of world sovereign debt. Meanwhile, those "risky" EM nations also count for 40% of the world's GDP, but they have only 10% of the sovereign debt. And their annual growth rates are quadruple (or better) that of their developed market counterparts.

As Spain, Italy and the U.S. begin to droop under the weight of their burdens, Chile, Korea and Colombia are saving their allowances. Positioning themselves for future league MVP awards.

Investors can purchase broad baskets of EM bonds through an index. Those indexes can yield nearly 6.5%, a 4.5% spread. With less than 25% of the debt. PowerShares' EM Sovereign Debt index (NYSEARCA:PCY) yields nearly 5%. Oh, and it's up over 14% on the year. Equity-like returns, without the volatility. iShares offers a similar alternative in its JPMorgan USD Emerging Market Bond ETF (NYSEARCA:EMB).

Don't like sovereign debt? Then opt for the corporate alternative, iShares' Emerging Markets Corporate Bond ETF (BATS:CEMB), or even the high yield EM investment, iShares' Emerging Markets High Yield Bond ETF (BATS:EMHY). All have done quite well over the last year. All will continue to do all right, so long as their patron nations maintain their increasingly strong balance sheets and growth relevance.

On the equity side, while they will remain volatile so long as Europe's debt contagion rages, EM stocks are trading at a 20% to 30% discount to U.S. equities. Vanguard's emerging market equity index (NYSEARCA:VWO) or iShares' MSCI Emerging Markets Index (NYSEARCA:EEM) both provide excellent means of hitching an allocation to these rookie sensations.

If everyone admits that EM nations are the growth engines of the global economy, then why are they trading at such discounts to their aging, over-indebted, bickering developed-market counterparts?

Because investing habits, like all habits, die hard. Like Bruce Willis. Or Michael Meyers in Halloween 6.

But they do eventually die. And when they do, you do not want to be the last guy on the deck of the Titanic, still waiting for the waiter to bring your gin and tonic, even as the boat begins to list uncomfortably, and the women and children have all but disappeared.

Disclosure: I am long PCY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.