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"Emerging markets" — handle with care

Our cover story on international investing (available to subscribers) in the March issue of the Sound Mind Investing newsletter spent some time discussing "emerging markets."

We mentioned that while there's so no precise definition as to what constitutes an "emerging" market, the term generally refers to nations that are "experiencing significant levels of economic development and reform."

David Callaway of Marketwatch opened a recent column on "eternal emerging markets" this way:

A fund manager at an emerging markets conference I covered more than a decade ago delivered a warning to investors infatuated with those markets that aged well.

"Did anyone ever notice that the emerging markets of the 1990s are the same emerging markets of the 1890s?" he said to a surprised audience.

It's an interesting — and valid — point. For all the chicanery that goes on in our own markets, the corruption and interference in many smaller foreign markets is an order of magnitude worse. Callaway writes that while our markets may be obstacle courses, at least they're not minefields.

In other words, there are good reasons why many of these markets stay perpetually emerging, but never quite emerge.

Emerging markets have been so hot for so long (20%+ returns every year since 2003, with the exception of 2008's big down year) that it's easy to be seduced by the easy returns they seem to offer. And, in fact, investors following our SMI Upgrading strategy have benefited from emerging markets in a significant way through many of the recommended international funds we've recommended in recent years, which often held above average allocations of emerging market stocks.

Just don't lose sight of the risks. The late 1990s offered a crash course in how contagion can spread from one emerging market to the next. And this year, surprisingly, has reminded us that the dollar can pivot quickly and unexpectedly, wreaking havoc with international returns over the short-term.

Emerging markets, for all their potential, are still volatile enough to carry a "handle with care" label. A little can be good, but this is definitely a case where more is not always better.

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