Of course the two largest stock exchanges – the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ) – both reside in New York City, but there are actually 19 global stock exchanges (as well as a number of commodity exchanges) that list publicly-traded companies from around the world. These member countries fall into one of three categories:
Although developed markets receive the most notoriety as being the most ‘investable’ among market participants, emerging market economies make up roughly 80% of the world’s population and nearly 70% of global GDP growth – attracting a significant amount of investor capital in recent years. While many emerging markets are naturally primed to mature into developed economies, this evolutionary process is by no means consistent – it is highly dependent on the idiosyncratic traits of a given economy and can take several decades (if not centuries) to materialize. There are, however, a number of common variables that tend to expedite this developmental progression – including a nation’s geography, population, natural resources, and technological prowess. While some counties seem to be ‘stuck’ in the emerging market category, others have matured or are maturing at exponential rates. Take for example the two most populous countries in the world – China and India. Both have been emerging market economies for quite some time, but China’s rapid industrialization (largely driven by technology and infrastructure) has dwarfed that of India – resulting in tremendous growth that has since made the two nations nearly incomparable.
Although China’s political tactics are widely criticized, there’s no denying the growth potential of a well-populated, resource-rich nation at the forefront of innovation. In fact, the United States experienced a very similar period of rapid growth following World War II – building upon an economic base that quickly transformed America into an economic superpower.
As the war drew to a close in the summer of 1945, the U.S. economy was poised for growth in the midst of global uncertainty. Not only had America defeated its enemies abroad, but the massive mobilization effort put millions of Americans back to work in well-paying defense jobs. Unemployment, which had peaked at 25% during the Great Depression, had declined from 14.6% in 1939 to a record low of 1.2% in 1944 – creating an appetite to spend unseen since the 1920s. In addition, the G.I. Bill – officially known as the Servicemen’s Readjustment Act of 1944 – made home ownership and college education accessible to millions of veterans. Of course these new homes had to be filled with furniture and appliances, and what’s a new home without a new Chevy sitting in the driveway? In fact, companies like Levitt & Son – a real estate development firm based in New York – applied mass-production techniques of the auto industry to home building, developing over 17,000 homes between the mid-1940s and early 1960s.
While rich natural resources and decades of infrastructural investment were obvious contributors to this growth, the exponential nature of said growth was largely driven by innovation. An increasingly educated workforce – many of which were returning veterans – began to embrace new technologies like never before, igniting an industrial transformation that rebranded America as an epicenter for affluence and innovation. This combination of tight labor markets, loose fiscal policies, and technological empowerment led to a capitalist-fueled expansion that would extend well through the 1950s – allowing a once crippled nation to quickly evolve into the strongest economy in the world. Despite the uncertainties facing America in the mid-twentieth century, had you invested in the S&P 500 in January of 1950 you’d be sitting at a total (inflation-adjusted) return of nearly 2,350% – an astonishing number that would’ve required decades of patience and a keen tolerance for risk. While this may seem lucrative in hindsight, can you imagine the number of financial crises one would’ve had to endure? I’ll give you a hint – every recession over that same period is highlighted below in gray; 12 recessions is no easy feat, even for the most seasoned investors!
The same goes for investing in emerging markets today – greater return potential will undoubtedly be accompanied by greater risk, and a sound risk assessment should begin with examining some of the common macroeconomic factors discussed earlier. Emerging market investors should also be cognizant of geopolitical risks that may arise in less developed nations – particularly those pertaining to economic instability or political corruption (the two of which often go hand-in-hand). China is once again a great example of this – its economic health seems quite robust on paper, but recent actions taken by the Chinese government have caused enough market turmoil that some investors have chosen to completely disassociate from the country.
At Silicon Hills, we believe that emerging market investments can add tremendous value to client portfolios – but only when executed through a lens of quality and diversification. Concentration in any given market can quickly disrupt the optimal risk allocation within a portfolio, and placing greater emphasis on sound fundamentals (i.e., cash flows, earnings, debt ratios, etc.) can avoid the speculative names most susceptible to emerging market geopolitical events. While there is much to be said about the common factors contributing to emerging markets’ developmental progress, these metrics should merely be viewed as a top-down barometer when assessing relative opportunities. Country-specific risks should be carefully scrutinized and well accounted for within the portfolio, and investments into such markets should be executed in a disciplined manner so as to mitigate the impact of unforeseen tail risk events. Understanding the unique characteristics of emerging market investments, we rely on the power of data to monitor the relative strength of emerging markets and partner with equity managers who emphasize quality over speculation – both here and abroad. So even if you don’t have the chance to step out of the backyard and across the pond, our clients can rest easy knowing that such exposure is being obtained in a disciplined, risk-aware fashion.
1 Developed Markets are the most developed in terms of their economies and capital markets, which include the United States, Australia, Japan, and most European countries.
2 Emerging Markets share some characteristics of developed markets, but are not fully matured in terms of technology, infrastructure, or capital market efficiency. These economies are characterized by rapid expansion due to high production levels and significant industrialization, and thus tend to offer the greatest return potential – albeit at elevated levels of risk. The most prominent emerging market economies include China, Brazil, Russia, India, and Mexico.
3 Frontier Markets are smaller, riskier, and less accessible than emerging markets, but still investable when viewed in terms of the global investable market. Examples include Albania, Bangladesh, Botswana, and Estonia – many of which are receiving significant investment from more developed nations.
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