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By Martin Hutchinson
Director of Global Investing Research
Emerging-markets investing can be a strange business.
Most of the time, the process is fairly simple, and profitable. All one must do is to:
- Identify the two or three best prospective countries.
- Examine the economic and political prospects of each one (as well as the prospects of the accompanying companies).
- Decide which market will do the very best over the long haul.
- Make the investment.
Most of the time, profits are the net result. But it can make for a wild ride. Usually you really have to keep your eye on that "long-haul" objective, so that you can ignore the short-term fluctuations, some of which are caused by the most inane things imaginable. But if you stick to my emerging markets checklist, you will not only find that you're usually "fine;" you'll discover that you've typically got a nice profit, besides – meaning over time, you will actually do quite well.
The Bad Seed
Every now and then, however, one or more countries run by some really "Bad Actors" have their securities markets beaten down so far that their stocks are selling for maybe a quarter of their asset value. At that point, the savvy emerging market investor knows there's an opportunity. But there's also a conundrum – and a choice to make:
- Do you play the savvy and morally sensitive investor, and steer clear, despite the obvious profit to be made?
- Or do you play the savvy and swashbuckling investor, hold your nose, buy the beaten-down shares of some of that country's major companies, and hope to profit from the almost-inevitable bounce?
You see, a country is not like a company. Speaking in the 1970s, famed Citibank Chairman Walter Wriston observed that "Countries can't go bankrupt." Of course, Citi found that precept was rubbish when all its Latin American debt was in default and it had to be bailed out by the Federal Reserve in 1991.
Nevertheless, while investors in Bad Actor Debt will generally lose their money, Bad Actor Equity is often a quite profitable speculation. If the companies in a country are solid, not overleveraged, involved in decent businesses and without too much exposure to the banking sector – which Bad Actor Governments tend to loot – these may well emerge in fairly good shape once the clouds of the financial crisis dissipate. Indeed, if the Bad Actor Currency collapses, Bad Actor Exporters should do quite well and be very profitable for a few years to come.
Russia is a prime example – and may represent the ultimate Bad Actor Investment.
As you'll recall, that country about went bust in August 1998, and anyone who had invested in Russian stocks lost nine-tenths of their money. The RTS dollar stock index of Russian stocks, which had peaked at 550 in 1997, bottomed out at 50 in September 1998. During late 1998 and 1999, Russia appeared to be descending into anarchy.
Time to buy! As is well known, from the anarchy emerged the sinister – but highly capable – Vladimir Vladimirovich Putin, and Russian stocks rebounded. By January 2000, the RTS Index was trading over 100. By 2001, it was fluctuating around 200. And by mid-2002, it was at 350.
A very nice since 1998, but no point going in at that stage, right? Everybody was optimistic about Putin, and the Russian economy had recovered nicely in 2001 and 2002. Even the Russian state budget was in better shape after the government had introduced a flat tax. If you had known in August 2002 that over the next five years Russia's largest company would be dismembered and its CEO sent to a Siberian jail, that the two largest foreign investments in Russia – those of Royal Dutch Shell PLC and BP PLC – would be largely expropriated with laughably small compensation, and that Russian foreign policy would turn into a re-run of the Cold War, you would have avoided Russian investments like the plague, wouldn't you?
You'd have been wrong. Even though the RTS index in 2002 was well back towards its 1997 speculative peak, in the last 5 years it has risen from 350 to around 2,000, a profit of more than 400%. Just buying the huge oil company Gazprom – surely the most completely obvious investment if you were going to buy Russia at all – would have netted you eight times your money as shares raced from $5 to $40.
At this point? Heaven knows. Probably the only thing that would make the Russian stock market go up even more would be for the country to start World War III and win it. At 40 times its 1998 price, the market is surely fully valued, while private property has no rights in the country and local businessmen run the perpetual risk of an unfriendly knock on the door at 3am. At any rate, with Russia part of the fashionable "BRIC" collection of Wall Street's favorite emerging markets, even the most devout Russian optimists can hardly claim the place is undiscovered.
Take another example: Argentina. In 2001-02, Argentina defaulted on its international debt, while the currency collapsed from $1 to $0.25 overnight. Most local savings were forcibly converted from dollars into pesos and a hard-left anti-American government came to power, vowing to pay not a penny to the unfortunate Italian bondholders who had invested in Argentine debt. Nobody but a madman would have invested in the place, surely?
Well, guess what? Argentina's Merval stock index, which bottomed at 200 in 2001 and stood at 390 in August 2002, after the worst of the storm had passed, is today just over 2,000. Again, a 400% – or even 900% m – for investing in a country that is truly appallingly run, with price controls everywhere, the head of the Statistics Office fired because she wouldn't falsify the inflation figures, and the leftist president's dozy wife poised to win election in her own right in October.
Whereas my investment recommendation on Russia today would be fairly neutral, on Argentina I would be heavily negative. It doesn't have Russia's geopolitical or natural resources strengths and it's even worse run because the Argentine government is less well organized than Putin's mob. My guess would be that Argentina is heading for another nasty crisis in the fairly near future – at which time it may again be time to pile in for a quick buck.
Regrettably, there aren't any good "hold your nose and invest" opportunities at hand right now.
Venezuela will be a good one when it runs out of money – its Orinoco tar sands are the world's largest and most valuable oil deposits. However it hasn't run out of money, yet, and the local stock market has done well, because it enables the unfortunate Caracas middle class to get their savings out to Miami. Bolivia and Ecuador would be good examples, but they are too small to have anything worth investing in. Good opportunities may arise when and if the U.S. subprime mortgage crisis spreads to emerging markets, but that hasn't happened yet, and doesn't appear to be imminent. Money Morning will keep an eye open, however, and alert you when the Bad Actors Guild sets up shop somewhere, and turns a disaster into an investment opportunity.
So, for the moment, you'll have to stick to investing in well-run countries, with good growth prospects. How boring!
Related News and Story Links:
- Money Morning News Analysis: Why Libya and Algeria Could Be Europe's Solution For Oil.
- Wikipedia: Vladimir Putin.