Have Emerging Markets Become Submerged Markets?
October 9, 2008
By Ron DeLegge, Editor

SAN DIEGO (ETFguide.com) - It wasn’t supposed to be like this.

Emerging market stocks were supposed be the future of investing. They were a source of spectacular gains. In fact, they were so invincible it was believed by some they were disconnected from the problems facing developed economies in Asia, Europe, and the United States.

As it comes to turn out, emerging markets are far more intertwined with the rest of the world than what those unreliable TV analysts reported.

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From 2003 to mid-2008 the MSCI emerging markets index enjoyed annualized gains of 29.75 percent and outpaced U.S. stocks by a wide margin. Investors couldn’t get enough. Back then, stocks from emerging economies led on the way up. Today, they’re leading on the way down.

How bad has it gotten?

Broadly diversified funds like Vanguard’s Emerging Markets ETF (NYSEArca: VWO) and iShares Emerging Markets ETF (NYSEArca: EEM) have lost about half their value this year. And ETFs following single emerging market countries have fallen about the same or more.

Emerging markets usually refers to countries whose financial markets and economies are still in development mode. Let’s take a quick gander at what some of the world’s largest emerging economies have been up to.

Russia
Russia’s stock market was closed several times as the country’s brass scurried to devise a plan. The Kremlin’s $200 billion rescue package has done little to stop the downward spiral in stocks. Confounding Russia’s problems is that Russian companies secured loans backed by inflated stocks as collateral. As stock prices fall, the collateral gets called in and stocks are sold at even lower fire sale prices. The Russia ETF (NYSEArca: RSX) has sunk 63.7 percent this year.

China
China’s economy is slowing down much faster than analysts had predicted. While its financial system hasn’t yet been hit as hard as the Europe’s or the U.S., the global financial turmoil has dampened demand for its exports. Yesterday, China’s central bank cut the benchmark one-year lending rate to by 0.27 percent.

Chinese stocks have thus far responded by collapsing. Since the beginning of the year, the iShares FTSE/Xinhau China 25 Index Fund (NYSEArca: FXI) has melted 50.6 percent and the SPDR S&P China ETF (AMEX: GXC) has fallen 51.4 percent. FXI follows a basket of 25 large cap blue chips, whereas GXC contains a broader mix of large, mid, and smaller stocks.

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India
India is another mega-emerging market that hasn’t been spared. The value of real estate is falling, mortgage rates are rising, and consumers aren’t consuming. The same vicious deflationary environment that has afflicted the U.S. seems to be at work.

India’s Reserve Bank reduced the cash-reserve ratio for banks in order to inject liquidity into the country’s ailing banking system. The WisdomTree India Earnings ETF (NYSEArca: EPI) has declined 47 percent this year.

Brazil
Another mega-market is Brazil. After averaging 20 percent plus gains over the past 10 years, Brazilian stocks were among the world’s top performers. This year, the iShares MSCI Brazil ETF (NYSEArca: EWZ) has melted 54.2 percent. This puts Brazil right in line with horrific performance of other emerging market countries.

Without much surprise, funds that follow “BRIC” nations (Brazil, Russia, India, and China) have been caught in the downswing too. The Claymore BNY BRIC (AMEX: EEB) has dropped 53.9 percent this year.

In 2008, emerging markets have indeed become submerged markets. What now?

Despite the dramatic declines, it does not necessarily mean you shouldn’t invest in emerging market stocks. Some of these very countries may return to their former glory. Also, emerging markets are a vital asset class that all well built and diversified portfolios should have exposure to.

What Now?
If you’ve gotten whipsawed by the poor performance in emerging markets funds or stocks, now is a good time to revisit your portfolio’s asset mix. Why did you get hurt? Maybe it’s because you overdosed on your exposure to these stocks. Learn from your mistakes, don’t perfect them.

If you’re confident in the future prospects of emerging economies, now may be an excellent time to add more positions. The world’s current financial crisis won’t last forever.

Also, you may want to try owning funds that have lower exposure to emerging markets like Vanguard Total World Stock Fund (NYSEArca: VT) or the SPDR MSCI AWCI ex-US (AMEX: CWI). Either fund is an excellent choice for a core foreign stock holding.