Friday, September 23, 2011

Emerging Market Update

On August 1st I wrote a cautionary note on emerging market investments--their stocks, bonds, and currencies.  It wasn't that I thought the long-term prospects were poor.  It simply seemed to me that the positive long-term case based on superior economic growth, lower debt, and favorable demographics was already well reflected in market prices.  

Brazil, for example, has vast water resources and surplus arable land, which will be two increasingly valuable resources in the years to come.  But so many investors had been attracted to Brazil that its currency had soared in the past two years, and demand for the high interest rates on its bonds led the government to impose a fee on foreign capital inflows.

This is an example of the importance of being able to distinguish between long-term, strategic investment positions and shorter term, tactical considerations.  One must not be complacent about any investment holding these days, as amazing market volatility has unnerved even professional investment veterans.  

To continue with the Brazil example, in the last month its currency--the Real--has fallen 16% versus the U.S. dollar.  That's a drop in a dollar-based investor's Brazilian holdings of 16% in a month just due to currency fluctuations!  As an aside, I'd recently wondered whether despite the obvious troubles of the U.S., the U.S. dollar was forming a technical double bottom on a longer-term basis and could favorably surprise market participants (as U.S. Treasury securities have).  That also was a reason for my recent caution toward gold, since the dollar and gold in recent years often have moved in opposite directions.

So not only have Brazilian investments for U.S. investors fallen 16% in the last month because of currency changes, on a broader basis emerging market bonds have fallen more than 8% this month.  Again, remember the strategic versus the tactical.  And remember that when something is obvious to seemingly everybody, it often makes sense to head the other way.

Steve Lehman

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