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Politics And Emerging Markets


Sudden regime change is never the answer.

Developed market risks are greater than that of emerging markets.

Changing global dynamics makes local currency emerging markets investments increasingly attractive.

Whenever my opinion is asked about the political leaders of nations I write about like China, Nigeria, Brazil, USA or anywhere else.

My answer is always the same. Sudden regime change like that being proposed in Brazil is never the answer because firstly whoever comes in will have the same culture and secondly, nations are ruled by organizations and systems both informal and formal.

Simply changing the figure head meaning the party, President or Prime Minister does not really change the direction of a nation as nations like any other large complex organization are ruled by machines, governmental, institutional and political machines. Most of these continue even whether or not there is a President or Prime Minister.

This is because in every organization, there is delegated authority. In a government like the USA or Nigeria, there are tens of thousands of governmental decisions made every day from Cabinet level through to the municipal level.

Most of these will never be known by the President or leader of the country but these decisions do affect the nation in significant ways and there is nothing the leader of the nation can do about them because he does not know about them.

It was even said that during the height of the Second World War, Winston Churchill fell very ill and could not fulfil the function of government for months but the public remained unaware of this and the administration of the nation carried on fully.

The reason I mention this is that many investors focus far too much on political leadership and wait for regime change as though this is a panacea for the ills of a particular nation.

Will the removal of Dilma Rousseff or Jacob Zuma materially change Brazil or South Africa, the answer is probably no because the person that takes over is either going to be similar or will preside over a system and culture that is unlikely to change within the period of one or two democratic terms.

I am of the opinion that true political change can only come over at least one generation which puts the election watchers at a distinct disadvantage compared to those of us who are looking to invest over generations.

We are able to look ahead and see outlines of what is to come and we gradually employ our funds to assist in the growth and development of the potential we see.

Using the orthodoxies of current economic thinking can make some investors invest funds with blinkers on, they focus on trends. If China was growing at 7% a year for the last four years then the next four years and more, they should also grow at 7% but when China begins to grow at 3%, many commentators begin to scream that there is crisis in China.

Conversely, another view is that there is a developed world with lower risk premiums and developing world with higher risk premiums but what we are increasingly seeing is that the lines between developed and developing are blurring yet the risk premiums are still not reflecting this new reality.

What then is the use of a political leader? A good political leader is a servant leader. When I see the current list of candidates running for the office of the President of the United States of America, I am filled with a sense of foreboding, far more than when I look at Brazil or South Africa.

This is because the office of the US President is not one to be approached lightly because it carries grave responsibilities but it is approached as if it were a beauty pageant or a competition of who can make the most realistic and ridiculous promises that they could never keep.

There has been very little in the way of first an acknowledgement that it is going to be a long and challenging road ahead.

The incoming President faces their most significant challenge at home. How can they bring together the warring factions in contemporary American society and achieve anything of note.

Every group has their cause and they are fighting for that cause whatever the costs to unity in the nation. This is true for the LGBT group, Immigrant groups, African American groups, Southern confederation group, Tea Party, Republicans, Democrats, Conservatives, Liberals, feminist, Corporate America, Workers Unions, the rich, the poor and so on.

At some level, each of these groups has legitimate concerns which needs to be addressed in a modern society but there needs to be a nationwide discussion about what it is to be American. What values should guide decision making and aspiration in the USA.

The USA has become like a married couple who have fought against each other so much that they cannot even remember why they are together in the first place and they continue to waste their lives going around in circles without achieving anything of note.

The new President's first duty is to unite the nation by identifying core values and goals that will be promoted on every level of society.

True leadership is about setting the direction, casting the vision and then empowering people to find their place and grow within that vision.

This is what the American President must first do because without unity in that nation, no program can succeed.

The sad part about this election is that the leading candidates are all very divisive and combative without that ability to build bridges across American society.

What does America stand for, this is what the world wants to know and this is what international investors wants to know.

In deciding who to vote for, the American people must think very carefully about their place in the world because at its essence, this is what is at stake.

Right now, I see more risks in the USA than most of the other regions that we currently see in the headlines like Brazil, China or even South Africa. There are various reasons for this but the main one reason is the legislative congestion. What is the use of having a democratically elected President and houses of legislature if they are not able to agree on anything?

The strengths of the USA were twofold. Firstly, it was a moral strength that arose from the shared values of the American people which valued democracy, free speech, democracy and the rule of law.

Secondly, it is its institutional strength within the global markets and in the various institutions like the IMF, UN, World Bank etc.

It is these strengths that has held the US as the only world superpower for generations but the foundations of these strengths are being tested particularly by security, economic challenges and an increasingly unequal domestic society where the poor continue to become poorer and the rich becoming richer.

How this great nation responds to these challenges will determine if it continues to remain a global superpower or if it fade away into mediocrity like other past superpowers.

If we continue to see legislative deadlock, civil unrest and inequality within the US economy then as investors, we will begin to raise the risk premium on US based investments and gradually diversify away from the USA.

The danger for the USA and the majority of the developed nations is that they risk losing their dynamism. The percentage of the young compared to the old is falling and in these nations, the young are not as politically engaged as they used to be.

Secondly, they have become used to the prevailing global order but this is changing and we are seeing new regional and international trade blocs, institutions and alliances being created globally to challenge the existing order.

This can be compared to the emerging markets where we are seeing an increased dynamism in the economies. In nations such as India, Nigeria, Kenya, Iran and South Africa, we are seeing an extremely vibrant start up ecosystem in almost every field.

These are driven by the increased opportunity to engage with global markets through the internet whether it is clients they are looking for, partnerships or financing and of course, these developments are affecting stock market returns.

These dynamics is changing our world around us but the market is still mispricing risks by increasing emerging market risks but decreasing developed market risks.

I believe that part of the problem for this comes from the risks inherent in the dollar because in times of low dollar rates, emerging markets investments increases but in times of higher dollar interest rates, there is a decrease as money is aggressively pulled out of these markets.

In essence, it is not really emerging markets risks that is overpriced but the risks that changes in the dollar interest rates will have on emerging markets investments.

The results of this is that emerging market economies are taking steps to mitigate the dollar risks on their economies in two main ways-;

Nations like Nigeria, Russia, China, Brazil and South Africa are taking steps to decrease imports and stimulate local production and consumption.

This is the ideal time to do this as in each of these economies, disposable income is rising, consumer spending is rising and also private sector credit is also rising.

The second step being taken by these nations is to be strategic in how incoming dollar investments is spent and reserves are increased when interest is low in anticipation of when rates increases and dollar outflows begin.

This model was really pioneered by Mr. Rajan and the Central Bank of India and it is a model being copied worldwide.

What is very interesting for me within this is that this is really the first time in about a generation that we are seeing truly divergent central banking actions around the world as emerging markets central banks realize that ultra-low interest rates pose a significant risk for them and they are doing all they can to shore up their positions.

The net effect of all of these is that it will significantly decouple the links between dollar interest rates and emerging markets investments.

This will make local currency investments far more attractive and profitable from both a risk perspective and a valuation perspective.

This is a process that I see consolidating over the next 12 months period especially if we see developed markets interest rates continue to stay low.

The main beneficiaries of these will be local currency ETFs like LEMB and FOILCBR. Both of which are currently are now moving significantly higher despite the headwinds of FED rates uncertainty and low commodities prices.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.