Emerging markets returned to their old form this year with a solid outperformance of developed markets in the United States and Europe.
By Nov. 8, the IFCI Emerging Markets index was up 38% from its position at the beginning of the year, compared with a 6% gain by the Standard & Poor's 500 stock index and modest gains in major European markets.
Year-to-date gains mask the remarkable recovery from the lows last August, which have fueled a more than 120% increase in Asian share prices and propelled Latin American equity markets by 40% even though much of that region is only now emerging from recession.
The recovery has been led by faster-than-forecast restructuring in Asia, the rebound of global commodity prices, a groundswell of interest in local equity markets by domestic investors, and encouraging growth prospects for 2000 in many of the major emerging markets. Analysts are describing the present environment as the early stage of a new multiyear investment cycle in emerging markets.
A growing legion of money managers, analysts and strategists think the twin engines of growth and declining interest rates and inflation will further coax foreign capital out of safe havens in search of performance and -- perhaps even more importantly -- encourage domestic investors to shift more resources from relatively stable local bond markets into equities.
"If there is a reason investors should buy emerging markets, it is that domestic investors in many of these countries have finally taken the lead in trading their own markets," said Alfredo Viegas, managing director of Stratos, a New York-based asset management firm. "Emerging markets rallied from last year without much foreign money, which means there has been a change in paradigm."
The shift was in evidence in Greece this year, where foreign money has comprised as little as one-tenth of daily trading volume, yet the country's ATG index rose 87% through Nov. 3 in dollar terms, the best performing market in the world following's Russia's 96% rise from a low base and on tiny volume.
"The implications for other emerging markets are staggering," said Mr. Viegas. The instability of economic policy in Greece "made investors keep their money in bonds. But as economic policy has improved and interest rates have fallen, this money has moved out of bonds and into the stock market, which has become easier for investors to access."
Good growth prospects combined with low inflation risk and inexpensive, free-floating currencies bode well for many emerging equity markets in 2000, provided the worst-case millennium bug fears of technological chaos and infrastructure paralysis are overblown. As Mark Mobius, managing director at Templeton Asset Management, said recently: "Emerging markets are better prepared for Y2K than developed markets. They have fewer computers, they are ready for disasters and they are not networked as much."
While this year's explosive performance has not resulted in an avalanche of new money coming into global emerging market funds, portfolio managers have reduced their cash levels to five-year lows in the hunt for dirt-cheap valuations that have been on offer for much of the year in Asia, Latin America, Emerging Europe and the Middle East/Africa.
Emerging markets are again an acceptable topic of conversation in more risk-averse financial circles. Emerging-markets money managers report the return of pensions and endowments to the area, with a number of managers describing the current request for proposals activity as the best in recent memory. One $40 billion corporate pension fund was reported to be lining up managers in mid-October to plow 5%, or $2 billion, into emerging markets by the end of this year.
On the sell side, investment banks since the second quarter also have been quietly and cautiously rebuilding their emerging-market teams -- primarily in Asian and Latin American equities -- in anticipation of continuing recovery in the asset class.
These banks aren't seeking much publicity for their efforts after admitting just one year ago to substantial trading losses in emerging markets. ING Barings has been on an aggressive hiring spree, particularly in Asia, because of a surge of new issues and underwriting mandates out of the region. Other banks known to be staffing up include Deutsche Bank, Merrill Lynch, Warburg Dillon Read, Donaldson Lufkin and Jenrette, ABN Amro and Salomon Smith Barney.
Just more than a year ago the death knell was being sounded for emerging markets, as equity markets had passed through the deepest and longest correction since data on these markets was first collected in the mid-1970s. And with the smell of default in the air, emerging-market bond spreads had skyrocketed from an average of 335 basis points over U.S. Treasuries in October 1997 to 1,500 basis points the following August.
This time of trouble that began with the devaluation of the Thai baht in 1997 reached its apex with Russia's domestic debt default and currency devaluation in August 1998, which sent shock waves throughout the asset class, and ended with the devaluation of the Brazilian real in January.
But just as the tail-end of the so-called Asian contagion was playing itself out in emerging Europe and Latin America, investors already were returning to scoop up bargains in Asia.
The buying continued strongly through the first and second quarters of this year in Asia, softened in the third quarter and had picked up again midway through the fourth quarter. In early November, the IFCI Asia index was up by more than 46%, with the top performers being Indonesia, up 77.4%; Korea, 59%; and India, 44%.
The IFCI Emerging Europe index was close behind with a 45% gain, led by Russia, 96%; Greece, 87%; and Turkey, 64%.
The Middle East/Africa index was ahead 27% -- with solid performances put in by Zimbabwe at 77% and Egypt at 40% -- while Latin America was up 21% on the back of a 43% gain by Mexico and 29% advance by Argentina.
Emerging market equity managers who are top-down are looking to a few choice markets in 2000 for the best performances.
Alfredo Viegas of Stratos Advisors Inc., makes a compelling case for Turkey in 2000. The portfolio manager argues that Turkey today is where Greece was four years ago, and he is making dramatic bets on the country.
"The EU has said that Turkey is a possible candidate for inclusion in 2005, real interest rates are in excess of 30%, the equity market is cheap on a global basis, and the majority of Turkish money is in bonds," he said. "That money will go into the equity market."
Many managers expect India to perform well next year because of the favorable October election results and projections of continuing strong growth. One such manager is Vincent McBride, with Warburg Pincus Funds in New York. He has a 10.5% allocation to India in emerging-market funds he manages, primarily in software and information technology companies, and is planning to increase his weighting to 15%.
Mr. McBride also likes South Africa, where he is now investing cautiously. He cites the recent change in government, good valuations and high-quality companies that are serious about restructuring as reasons to be bullish on South Africa.
Mark Madden, senior vice president of Pioneer Investment Management, Boston, makes a case for investing in Indonesia.
"Interest rates are down from 60% to 70% last year to 40%, and could drop to 8% to 10% over the next year," he said. "We think this market has tremendous upside potential as East Timor recedes as an issue. We think the risk premium will come down and a lot of foreign investors will be coming back."
And one asset manager has spotted an intriguing investment idea for 2000. "Liquidity has dried up in emerging market stocks in the last month and looks to get drier in everything except the largest stocks," said Joseph Williams, head of emerging markets at Batterymarch Financial Management in Boston. "That creates a value disparity. I think money will come back in 2000, and when it does I think it could take smaller stocks much higher than anticipated. A nice bunch of interesting, smaller companies could really shoot the lights out in 2000."