The developed economies are marked by two key conditions right now: cheap money and excessive government debt.
This is mostly a response to the financial crisis that struck in 2007. America, Europe and Japan had accumulated large debt loads before the crisis. But their debt loads grew even bigger, as governments there tried to borrow and spend their way out of recession.
Monetary conditions have also changed dramatically. Before the crisis, the benchmark interest rate in America was about 5%. Now, it’s as close to 0% as it can go. Rates are also close to zero in Europe and Japan.
Near-zero interest rates are supposed to stimulate growth by making credit easier to access. The problem is these stimulative policies are highly porous—they leak across national borders easily. So the easy money policies of, say, Washington can trigger inflation in Beijing, Jakarta and Bangkok, while leaving the unemployment high and house prices low in the U.S.
This highly fluid situation has caused considerable confusion for emerging markets investors. Seeing inflation tick up in the emerging economies, many of them have pulled their money out and put it back to work in domestic markets.
History suggests this could be a mistake.
To find the last instance of loose monetary policy and excessive government debt in the developed world, you only have to go back to early 1970s America.
Would investors have been right to bet on America back then?
As John Mauldin points out in his new book, Endgame, the answer is a resounding “no.” According to his research, if you had invested $1 in the U.S. from 1970 to 1985 you would have ended up with $2. But if you had invested $1 in Japan over the same period, you would have ended up with $6. And if you had invested in Hong Kong, you would have made $8.
Mauldin’s point is simple: The emerging markets will be the big winners of the loose monetary policy and excessive government debt in the developed world.
The Fed is printing money at a staggering rate. Since last November, it has been injecting about $4 billion a day into the U.S. financial system. This money has to go somewhere. And if U.S. consumers refuse to borrow and spend, the most likely destination for that cash is the emerging economies.
Right now, this is causing inflation rates to tick up in emerging economies. And it’s forcing governments there to try to keep prices from rising with higher interest rates and capital controls.
But these are short-term concerns. Over the long run, five key factors will cause the emerging economies to outperform the “submerging” economies of the U.S., Europe and Japan. According to Mauldin, they are:
- Generous liquidity, that is, rapid monetary expansion
- Positive demographics
- Declining real interest rates
- Underleveraged consumer
- Banking sector with low loans-to-GDP ratio
Eventually, we’ll probably see bubbles forming in these markets, as capital from abroad overwhelms their relatively small stock markets. (The market capitalization for the entire Indonesia stock market, for instance, is less than that of oil company Exxon Mobile.)
But on the way, fortunes will be made.
Brazil is still my favorite of these five markets. Brazil has raised its key lending rate by 1% to 11.75% so far this year. This is scaring off investors. But once the interest rate cycle peaks (rates there are expected to peak at about 12.5% this year) Brazil will be back in favor again.
I’m not waiting for the rest of the market to rediscover Brazil’s potential. Next week, I’m flying to Sao Paolo to get a better read on the Brazilian story firsthand. I’ll be meeting with experts in agriculture, offshore oil and infrastructure.
In the meantime, consider adding some broad exposure to Brazil by way of theiShares MSCI Brazil Index ETF (NYSE:EWZ). Top holdings include state oil giant Petroleo Brasileiro (NYSE:PBR), iron ore produce Vale S.A. (NYSE:VALE) and Brazilian bank Itau Unibanco Holding Financeira (NYSE:ITUB).
I’ll have more from you from the ground in Brazil when I get there.