Emerging Market Investing

Paul Lim had a good column in yesterday's New York Times about investing in emerging markets stocks.

Mr. Lim pointed out that it seems almost universally accepted that investing in the emerging markets makes sense. However, the performance of this sector has been mixed so far this year, largely lagging the gains in the S&P 500.

Unlike the Federal Reserve and Bank of Japan, most central banks in the emerging economies have been struggling to rein in growth and inflation. The Bank of China, for example, has raised rates several times this year trying to slow growth, as has the Brazilian central bank.

The actions of the central banks, combined with attempts by governments to slow down the rate of inflows from overseas investors, have curtailed gains in emerging markets stocks relative to the U.S.

The article also notes that stocks in the emerging markets economies are more tied to commodity prices than might be generally perceived:

International stocks generally have higher correlations with commodities markets than do domestic equities. While energy and materials companies make up less than 16 percent of the S.& P. 500 index of domestic stocks, those two categories account for 27 percent of emerging-market stocks.

The Allure of Foreign Stocks Starts to Fade - NYTimes.com

Emerging markets bond funds have also seen large inflows, which has pushed yields in countries like Brazil and Mexico to levels lower than many European countries. As this morning's Financial Times reports:

The credit default swap index for 15 major emerging market countries has fallen by a third to 206, while the iTraxx SovX index for western European CDS has climbed to almost 190.

I agree that, longer term, the emerging markets offer an appealing combination of strong economic growth and powerful demographic tailwinds.

However, the ride forward will not be smooth, and the emerging markets probably carry more risk than investors are currently perceiving.

Meanwhile, high quality, dividend-paying US stocks continue to trade at attractive valuations, especially if current economic slowdown persists.