Submerging Markets: What the Emerging Market Selloff is Telling Us

Investing at its most basic level is about one thing: the return you seek on your investment and the risk you take to get that return. I often emphasize that the biggest “risk” to investors is volatility, because it’s the occasional shakiness of markets or market segments that causes investors (whether they manage their money or have someone else do it for them) to react emotionally instead of logically. That plays out every day in markets around the world.

Anyone who has been an investor for the past five years knows that “normal” does not describe what has occurred. Violent declines and equally exuberant rallies in stocks, the Fed and Central Banks around the globe pumping up economies and banks, and traders and hedge fund managers doing what they do best: providing needed liquidity to make markets more fluid to operate in…but also whipping markets around from time to time, frustrating the long-term investing crowd. It is like the person who just wants some peace and quiet at home, but the damn dog from next door will not stop barking at 5AM (my family’s dog Roxy has been that dog!).

I think that is one factor contributing to the fact that through June 12, the S&P 500 Index was up 14.18% for the year but the MSCI Emerging Markets Index was at 9.55%…that’s DOWN 9.55%! This continues a pattern that has existed since before this year, though it must be mentioned that Emerging Market indexes are falling after a sharp rally earlier this year. For investors whose long-term portfolio strategy includes a portion invested in Emerging Markets, this means you have likely earned much less than the S&P 500 Index over the past few years. This is not the first and likely not the last time this will happen.

This puzzling separation between the U.S. and Emerging Markets is a microcosm for what is so strange about 2013 in general – the distinction between what is a conservative and aggressive investment is all screwed up. Aggressive investments are supposed to do better when markets are generally up. That is not happening as it normally does. From the research I did this week, we appear to be near all-time highs in the degree of underperformance of Emerging Markets versus the S&P 500.

Emerging markets are a double-edged sword: since they are smaller, they can be swung around more easily over short-term periods of time. Yet with Asia in particular, there is a secular force that is undeniable to me. As China and the surrounding countries modernize and a middle class develops, much like the U.S. in the 1950s, the companies that are in position to profit that surge in consumerism could be big winners. This is one of our 10 major investment themes, from which our investment ideas are sourced.

As powerful as the long-term Emerging Markets Consumer theme is, Emerging Markets “submerge” as they have, we have to consider that within the volatility management mantra which is the core of our investment approach.

© Sungarden Investment Research

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