The MSCI Emerging Markets Index lost 9.9 percent of its value year-to-date as of August 31. The so-called BRICs (Brazil, Russia, India and China) have led the way down, as the MSCI BRIC Index lost 12.2 percent.
The year thus far has been marked by social unrest in Brazil, chronic political corruption in Russia, a currency crisis in India and the aftermath of a bank loan bubble in China. Emerging market securities have been hit by fears that an end to an easy monetary policy in the U.S. could halt economic growth in these countries and discourage outside investors. Geo-political risk has come to the forefront, most notably in the Middle East, overshadowing concerns over the precarious state of fiscal health among developed economies.
Worried investors have pulled billions of dollars out of emerging markets funds over the past eight months.
This is a remarkable turnaround from only a few years ago, when emerging market stocks were widely considered a “must have” asset class. The so-called lost decade among U.S. stocks had just concluded, with the S&P 500 closing 2010 with a 10-year loss. Predictions of further sub-normal returns for U.S. equities were pervasive. During 2009 and 2010 emerging market stock returns had nearly doubled those in the U.S. Investors were told that emerging markets had “de-coupled” from developed markets and that strong internal consumer demand and high GDP growth would extend those gains. Emerging economies were lauded for their better pre-crisis fundamentals, and for prudent fiscal policies learned the hard way, after years of debt crises and defaults. The “old world” would be hampered by endless Japan style deflation, while emerging economies would be the engines of world growth. What is the takeaway for investors?
1) Emerging markets are extremely volatile and react quickly and strongly to breaking news, good or bad.
2) Equity prices are forward-looking and useful in predicting economic growth, but the reverse does not hold. Therefore, expected equity returns and economic conditions tend to be counter-cyclical. Good economic news is priced almost instantly in the form of higher equity prices, so prospects for higher returns are commensurately lower. By the same token, expected returns are higher when bad news has arrived and are reflected in lower security prices.
3) These turning points are only obvious in retrospect. Long-term disciplined investors will benefit from the growth, diversification, non-dollar currency exposure inherent in emerging markets. The best approach is to include emerging markets in a well-diversified portfolio rather than embracing them when the news is good and fleeing them when news is bad.
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The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
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