Emerging Markets are Trash
I write this post seeking some sort of cathartic denouement towards my decade-plus affair with emerging markets. While probably not as regretful as a crypto enthusiast who blew away 99% of his life savings in Dragonchain over the last 12 months (seriously, who could have ever seen that ending badly?), EM has nevertheless been a complete, unrepentant dumpster fire of an investment. It’s never a good thing when you assign human attributes towards your investments, but I can only come to envision EM as some type of demented siren luring value investors from afar:
“Oh, look at my valuation! It’s so charming. It’s so cheap! Don’t you remember what happened in South Korea and Japan? The development. The growth. The innovation and creation of world class dynamic economies. LOL just kidding you just bought BRAZIL, TURKEY, and RUSSIA. Have fun!”
In hindsight, the alarm claxons should have sounded loudly in my head from day 1.
My Affair With EM
Looking back on it all, it’s directly related to your formative ideas when you first become cognizant of the brave new world out there. For me, it was the heyday of the late 90s. The US was running a budget surplus, the world loved America, the Cold War was over. The global community were all tripping over themselves to get McDonald’s, Wal Mart, and Chevrolet into their markets, and for a glorious several years it seemed like at last democracy and free markets were to to triumph. All those dumb commies in the former Soviet republics would obviously soon double, triple, quadruple their output because I mean its democracy and capitalism. How could they be denied?
In the late 90s and early 2000s, emerging markets crushed it. Unfortunately I didn’t really have any great knowledge of “Asian Financial Crises” or any banal details like that. All I knew was when I went and looked at Motley Fool for a reference on ‘which mutual funds to buy’ at my local book store (Amazon? Isn’t that a river in Brazil?), “Emerging Markets” always seemed to be killer. And whats not killer about emerging markets? It’s sexy, a new frontier for undeveloped opportunities. Just think, as soon as they emerge, they’ll be challenging the United States for dominance. Billions of people around the planet, all geared up and ready to create nominal GDP per person of $60,000/year, and all unleashed because they’d been mismanaged for far too long.
In hindsight, when “Financial Crises” wipe out 70% of the equity value of these markets, its probably well advised to file a mental note that ‘hey, that’s a thing that just happens in these markets.’ Instead, all I saw was killer returns in the late 90s and the idea of the Pax Americana bringing the enlightened zest of capitalist markets to the darkened corners of the globe. What could go wrong?
“Emerging” Never Emerged
The narrative formed, and I bought into it wholeheartedly during and immediately after the Great Recession. The only problem with that (as the graph above illustrates), the average total return (annualized) from 2010 to present for EM is about 2%, compared to 12% for the S&P 500. 10% per year?!? That’s an incredible opportunity cost of having money tied up in such a turd parade. Over the last decade, every dollar invested into American markets has returned 2 friends while EM has returned a huge heaping load of zilch:
So what the hell happened? How did ’emerging’ never emerge? The GDP of Brazil, Russia, and Turkey grew, albeit at an extremely volatile growth trajectory plagued by frequent recessions:
Not a great story, but one forgiveable. Sure, they’ll never be mistaken for South Korea that banged off 10% annualized growth consistently from the early 1980s until the late 1990s to form the hyper modern and competitive nation that Korea is today, but that is hardly an indictment of emerging markets in general. No, the failing is something far more obvious when one bothers to think about it. EMERGING MARKET ECONOMIC GROWTH does not imply EMERGING MARKET COMPANIES ARE PROFITABLE.
Dr. Ed Yardeni’s research is a wonderful repository for all economic indicators, and has wonderful data related to Emerging Markets. In the depths of his research, the logic behind my worst investment becomes brutally clear. Emerging markets have created absolutely no earnings growth, at all, over the last decade:
I mean, it seems so obvious when you bother to stop and think about it. Who is driving global ingenuity and innovation? Is it going to be Google and Amazon and Facebook or some third rate industrial manufacturer in Sao Paulo who has to 1) pay a whole bunch of elevator operators because the government tells him to 2) pay off the corrupt government for a license to operate and 3) deal with the most complex tax regime in the world?
The Final Straw
Troubling as I began to slowly digest the transformation in my thinking in early 2018. Two completely unrelated things occurred to completely shatter my emotional fling with EM once and for all back in May. First, as I drove to work one day I listened (as I always do and fully recommend) to Bloomberg Surveillance with Tom Keene. At the time, Erdogan in Turkey was beginning to assume the mantle of not only autocrat and despot but also central banker, taking the reigns of interest rate policy firmly in his hands. “Holy shit, that idiot thinks populism makes for good, sound interest rate policy?” was my first thought. Followed shortly thereafter by my recollection of a book I was reading.
Those of you who read this blog may have ventured over to the history section (a shameless plug, go here if you like history). At the time I was reading about the formation of Japan in the mid to late 1800s and how those events led to Imperial Japan’s involvement in World War II. What stood out to me is that Japan was basically a medieval, feudal society as recently as 1850 when Commodore Perry forced the markets open under the barrel of a gun. By 1870, they were learning everything they could and building Western style shipyards. By 1905, they were defeating Russia in a naval war, and by World War I were a first rate global power.
Now THAT is how a market emerges. When I juxtaposed that with the Erdogan example, all I could think about was how the same poorly administered, corrupt nations that were ’emerging’ 20 years ago are still trying to emerge today. And they’re still held back by poor governance, little fiscal discipline, a weak profit motive to actually ever expand earnings, and simple outright corruption.
But what about China? Yes, why not invest in a controlled economy whose primary interest is in sustaining the hierarchy. One who props up phantom companies and real estate ventures, engages in questionable accounting practices, and is saddled with a demographic time bomb. One who builds ghost cities for little discernible purpose. One whose business owners circumvent capital restriction laws by buying foreign properties around the globe.
Why not, indeed.
I immediately sold every share of EM I had that day and haven’t looked back. Some things are cheap not because they are undervalued but because they actually aren’t worth much.
Sorry, EM. I’m through with you. To remember each other, we’ll always have that decade together where you were literally the one asset class to return nothing. Impressive, it’s like falling out of a boat and not getting wet. But you pulled it off!