How to Invest in Emerging Markets Using One Simple Strategy

Knowing the secret to how to invest in emerging markets will let you tap into the hottest global growth while avoiding traps - like this country has become...

This year marked a raucous end to one of the greatest economic booms in the last 100 years.

It happened in June, when more than 1 million protesters took to the streets in one of their country's largest cities.

At the time, they raised ire about steep increases in crime, inflation, and political corruption. They stomped the pavement over ill-gotten decisions to spend taxpayer money on posh football stadiums for the World Cup instead of schools, hospitals, and much-needed infrastructure.

This was the loudest uproar over the country's stumbling economy.

As consumption slows, consumer prices increase, and taxpayers continue to protest, we see an important lesson unfold from this country about how to invest in emerging markets.

In fact, it highlights the one simple strategy that can make you a lot of money...

Investing in Emerging Markets: Brazil's Rise and Fall

The protest I described took place in Brazil, which for nearly two decades enjoyed an economy that was nothing short of miraculous.

After an abrupt end to runaway inflation in 1994, a new currency, and liberalized trade laws, Brazil witnessed a massive influx of credit and consumption driven by a boom in commodity prices. It led to more than 25 million Brazilians rising from poverty.

The nation thrived under President Luiz Inácio Lula da Silva in the early 2000s, survived the recent global economic downturn with barely a scratch, and grew by 7.5% in 2010, the highest growth rate in 25 years.

Brazil shined as one of the most important emerging economies, coined in the BRIC acronym by a Goldman Sachs economist in 2001 with Russia, India, and China.

The nation's rise was so meteoric that the world united to award it the 2014 World Cup and the 2016 Olympics, the first South American nation to host the latter. The two events would showcase Brazil's arrival on the global economic stage.

But today, in just two short years, the economy is struggling. Brazil's stock market has fallen by 23% since Jan. 1, 2011. Investor capital is fleeing the country.

Slammed by rising inflation, a Byzantine tax code, and an inability to provide essential services to its people, Brazil became a victim of its own success and is now reeling from its boom years.

In 2012, the Brazilian economy grew at an anemic 0.9%. This year, its stock market is down more than 15%. Many have said that the boom years are dead, and now the country will suffer from its inability to reform the problems that plague its economy the most.

What's the problem - and what does it teach us about how to invest in emerging markets?

How to Invest in Emerging Markets: Play the Policies

Over the last 20 years, Brazil has done very little to reform its government.

In Brazil, companies now face the highest tax burdens of anywhere else on the globe in terms of its workforce. According to various reports, payroll taxes add an additional 58% to company salaries. Meanwhile, public sector pensions have reached unsustainable levels, as the average worker can obtain a 70% share of their final salary at the age of 54.

Total taxes have reached 36% of gross domestic product (GDP), the highest level in the emerging world and comparable to the basket-case economy of Argentina just to the south. And despite the downturn and rising entitlements, the government will not be able to raise taxes, despite desperate needs for hospital, schools, and infrastructure spending.

Meanwhile, inflation sits at 6%, and the cost of goods is rising steeply. According to The New York Times, a Samsung Galaxy S4 phone retailing at $615 in the United States is twice the cost in Brazil. A cheese pizza costs $30, and a Big Mac requires that the average person in San Paulo work nearly four times the amount of the average person in Chicago to afford it.

But worst of all, Brazil, which presents some of the best agricultural opportunities in the world, fails to properly allocate resources to the required infrastructure to help the nation thrive. The nation is the third-largest exporter of agricultural products, but infrastructure problems are driving up costs substantially.

Brazil only spends 1.5% of GDP on infrastructure like roads, ports, and railways, compared to a global mean of 3.8%. This has significant impact on various sectors, but agriculture is the biggest victim.

In Mato Grosso, a principal farming district in central Brazil, farmers spend 25% of their gross sales on shipping soy to ports, whereas the average Iowa soy farmer pays 9% to 10%.

Simply put, the country is not especially favorable to investment for its own taxpayers or for investors abroad until reforms are met.

This is part of knowing how to invest in emerging markets - looking for policies that support reduced taxation, increased transparency in government, and greater financial freedom.

How to Invest in Emerging Markets: The Best Strategy

Money Morning has discovered something every global investor should consider when evaluating foreign investment opportunities. We call it the "Liberty Investment principle."

This principle uses two tools to measure the economic liberty of a nation.

First, the Heritage Foundation Index of Economic Freedom helps investors understand the levels of taxation and government participation in the nation's market. The more freedoms granted to investors and businesses, the better.

The index also provides a scaled raw score to rank 185 nations on their economic freedoms, including property rights, investing rights, and taxation levels on businesses.

Money Morning's Martin Hutchinson first introduced the Liberty Investment principle to readers in 2012.

Hutchinson says that "each country should also have a high level of integrity - meaning they follow the rule of law. A good score on Transparency International's Corruption Perceptions Index is a good measure of this."

In both scenarios, Brazil drastically fails both tests. Brazil ranks 69th in transparency and 99th in economic freedom. So, it's no surprise that the country is struggling today.

Using this principle, investors have other countries to consider when hunting for how to invest overseas.

In South America, investors should instead look to Chile (currently the 6th freest economy, 20th most transparent), Uruguay (36th in freedom, 20th in transparency), and even Colombia (37th in freedom, 94th in transparency), the latter having made a significant amount of progress in the last decade. Meanwhile, investors should avoid Argentina (160th in economic freedom, 102nd in transparency).

Moving forward, Brazil will require a significant amount of reform before you should consider investing in the country's economy. Reforms to taxation, governance, and infrastructure spending are the only way that Brazil will emerge from its current quagmire and once again present opportunities to global investors that instill trust and long-term commitments to capital.

Wondering how to invest in Chile, one of the best emerging markets? We have three stocks for you.

About the Author

Garrett Baldwin is a globally recognized research economist, financial writer, consultant, and political risk analyst with decades of trading experience and degrees in economics, cybersecurity, and business from Johns Hopkins, Purdue, Indiana University, and Northwestern.

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