Reemerging Markets Essay Research Paper D FriarInvestments

Re-emerging Markets Essay, Research Paper

D. Friar

Investments 591

Monday, 27th May, 1997

Re-Emerging Markets.

During 1993, the buying fever for emerging market shares was at its peak and each day a mutual fund specializing in investment in ever more exotic locations seemed to appear. Mexico, Latin America and even post communist Eastern Europe were in turn touted as the next .dragon. economies of the 90.s. Unfortunately, anybody who put cash into an emerging market equity fund three years ago, lured by the promise of vast rewards, is likely to be feeling a little discontented. The International Finance Corporation.s (IFG) investable index, which measures the prices of emerging market shares that foreigners can buy (quoted weekly in The Economist, or periodically in Barrons) has fallen 7 percent in dollar terms from the end of 1993 to the first quarter of 1997. To add insult to financial injury Wall Street, as measured by the Standard and Poors 500 has climbed by 75 percent over the same period. To further rub it in the three major American indexes, The Dow Jones Industrial Average, the Standard and Poor.s 500 and even the lagging NASDAQ composite, reached record highs on Friday May 24. If an index containing Jordan, Estonia, Trinidad and Tobago, and Botswana, along with 24 other truly emerging nations can not outperform an index of America.s emerging companies is there any purpose to putting one.s money into such far-flung shares. In answer to this question this essay proposes to examine the current condition of emerging markets in light of recent disappointments from the end of 1993 to the present. It will be shown that the long-term benefits of such investments remain strong and alternatives to volatile direct investment exist.

Why have so many emerging markets failed to live up to their promise over the past three years. One reason is that they were over-hyped back in the early 1990.s, when the combination of low domestic interest rates and the misguided belief that small markets could only rise, caused vast capital inflows into the worlds smallest bourses. According to the Institute for International Finance, a Washington based association of the world.s major financial institutions, .The flow of private capital into emerging markets jumped to $105 billion in1993 from $57 billion in 1990. (Fuerbringer, page, c6). Further, in the Economist the scale of these capital flows is related by using the example of Hungary, .Which in 1994 received $1.1 billion in foreign investment, or $111 per person:. (The Economist, vol. 338, page100). Naturally, enough these vast new inflows caused equity valuations to rise to heights even economies with 6 to 7 percent annual growth in gross domestic product could not support. A pin was finally applied to this bubble during 1994 when six successive interest rate increases by the Federal Reserve Board challenged the twin assumptions of ever increasing returns from exotic markets. Now, for the first time since the moderate economic recession of 1991, the rates on domestic bonds turned upwards and offered a degree of competition to their less familiar brethren. The short-term and inevitable correction that followed would perhaps not have caused the lagging returns still felt today if the situation in SouthEast Asia and Mexico had been different. In the case of the Asian tigers, growth rates in the 8 to 9 percent range were already a thing of the past as these countries became ever more developed, and an overdue cyclical downturn was probably already underway by early 1993. For Mexico, the rising costs of selling debt to foreigners exposed its massive balance of payments problems and unsustainable level of government borrowing, which in turn precipitated the Paso crisis of early 1995 (Chote, page 7). Taken together these events caused declines in markets whose fundamentals remained unchanged by this short-term turmoil and caused many who saw emerging markets as a one-way bet to return to more familiar fields.

Does this mean that emerging market investment is an ill-considered adventure. Not necessarily. Emerging markets were always meant to be long-term investments and .from 1985 to 1995 the Morgan Stanley Capital International.s EAFE index of foreign stocks has significantly outperformed the S&P 500 – delivering a cumulative return of 403 percent versus 283. (Economist, vol. 337, page 121). However good though these numbers are, the rationale for an emerging market investment is perhaps best made in terns of the relative macroeconomics opportunities offered. The U.S., like most mature economies, has seen average growth of GDP of around 3 percent since the end of World War Two and yet the average multiple on an S&P 500 issue is 21.4 times earnings. In contrast to which the IFG.s expectations are for .5.7 percent expansion in emerging markets economies during 1997… and accompanying net direct, (non-governmental) capital investments of $240 billion.. This, the institute latest report argues, .represents an efficient allocation of world capital towards high-return investments, rather than the slide towards overborrowing that precipitated the debt crisis of the 1980.s. (Chote, page 7). From an individual investor.s perspective, the crux of the matter is that corporations are prepared to invest record sums in the smaller economies of the world because of the potential for growth is so strong. F