After Turkey's market rocketed last year, Malaysia's reached breathless heights, and the Philippines' index climbed to new stratospheres, it should have been time for pioneering investors to begin exploring the next tier, or so-called pre-emerging markets.
But that was not quite what happened.
Instead, data show small pre-emerging markets around the world - in Eastern Europe, the Middle East, Africa, the Caribbean and parts of Asia - had, in many cases, already joined last year's pack of high-fliers.
For instance, according to data from Birinyi Associates of Greenwich, Conn., Poland's market last year topped the charts with an 875% rise in dollar terms, Zimbabwe's market jumped an eye-popping 203.5% and Kenya's market soared 117.5%. This year, experts say, the pre-emerging markets sector in general has been outperforming the more developed emerging markets.
But with such gains already in place, some observers wonder whether the play in pre-emerging markets is over, at least for now. Is it worth trying to penetrate embryonic markets whose problems include custody, settlement, thin trading and stomach-churning volatility? The underlying economies of these markets also offered fewer attractions, at least until now, than those of Southeast Asia or parts of Latin America. For example, in quite a few cases, long-time socialist/leftist regimes in some of the pre-emerging economies spawned a reliance on government and a weak work ethic. In other cases educational and health standards might be substandard, and politics tumultuous.
But on the bright side, a number of close observers believe the bad old days of despotic rulers and ruinous economic programs are waning even in the poorest lands. And their stock markets, some of which have been overrun with speculation, are beginning to attract serious long-term institutional assets. With that will come better research and investment practices, some predict.
"The run-ups in some of the pre-emerging markets were based on local investors' ignorance," declared Simon M. Edwards, a pre-emerging markets analyst with Baring Securities in London. "Someone in Zimbabwe (where the market opened to foreign institutional buying last year) would put up a hand and say, 'The foreigners are coming. Let's buy up all the stocks.' But they didn't know what they were buying."
Recent price escalation, he pointed out, doesn't shut out long-term opportunities in emerging markets. Certainly, the supply of available stocks in these markets is limited: the January Micropal Emerging Market Fund Monitor quotes Morgan Stanley Asset Management as saying Africa's newly emerging exchanges had only 12 liquid stocks with market capitalizations of greater than $100 million and only 25 with market caps between $50 million and $100 million.
But improvements in the quality and breadth of small markets are in sight, as economically emerging countries privatize more state-owned industries, and more local companies seize the chance to list shares in a rising market.
Privatizations are spreading rapidly throughout the developing world. Among the current examples, the privatization of Ghana's Ashanti Goldfields, one of the world's largest mines, is drawing ever more attention to that west African market. Morocco's $2.2 billion privatization program includes 112 companies, reports Baring Securities. Privatizations in some areas of Eastern Europe have been taking place on a massive scale, boding well for the future of local stock markets.
Besides privatization, poorer nations are agreeing to a host of other measures to obtain aid from such donor organizations as the World Bank and the International Monetary Fund. Aid recipients are having to undertake such measures as slashing their federal budget deficits, hosing down inflation and cutting taxes - all measures that are expected to help local companies deliver on earnings.
No wonder then, that as local confidence in pre-emerging economies rise, "you're seeing more local money returning; that was one of the factors that moved the Latin American markets in the early 1990s," said Elizabeth Morrissey, managing partner, Kleiman International Consultants, Washington. In addition, "many of the pre-emerging economies are still commodities-driven. And there's a major school of thought now that the 10-year bear market in commodities prices may be coming to a close."
In addition, the liberalizing of foreign exchange controls in countries such as Kenya will give companies more access to capital sources. And it also opens the stock market to more investors - at a time when improving stock analysis helps investors find out which companies will best succeed in a freer market environment. Thus, from the long-term investor's perspective, Baring's Mr. Edwards certainly believes "the run-ups in pre-emerging markets are not over."
But even recent gains could be deceiving. Narayan Ramachandran, managing director, Rogers, Casey & Associates, Darien, Conn., notes that "while it's true liquid indexed securities in many of these countries show observably high p/es, this ratio is not necessarily the best measure of valuations. Earnings in many of these countries are understated principally for tax avoidance."Understated earnings, in turn, help inflate p/es, he points out.
In addition, investors may not be aware of hidden assets of companies in these regions because of local accounting practices. For example, a lumber company might have "a whole set of timber forests" that may not be readily apparent on the financial statement, cited Mr. Ramachandran. In his view, "there's still plenty of opportunity" in emerging markets, although investors still have to be careful.
So, what are the most promising pre-emerging market regions right now? If flow of funds is a good barometer, then Eastern Europe seems to be in the lead.
Ian Wilson, editor of Micropal Emerging Market Fund Monitor, points out new Eastern European funds often are attracting more money than those of other regions, including Africa. Two recent examples are the $200 million Central European Growth Fund of CS First Boston and Baring Securities' $124 million Baring Emerging Europe Trust. In one comparison, funds for Africa have been tending to attract much less than $100 million. Why is Eastern Europe more popular? To Mr. Wilson, that region has among its attractions the advantage of having "a greater comfort level and familiarity" to many Western investors.