The Best Emerging Market of the 21st Century

The Smart Profits Report: Issue #316
Friday, June 9, 2006

The Best Emerging Market of the 21st Century
By Karim Rahemtulla
Chairman, Mt. Vernon Research

When I first started in the investment business, I spent more time on the road than in an office, exploring the exceptional opportunities that the best emerging markets presented.

More than a decade later, what was true then remains true now. Those same great opportunities still exist. But emerging markets like China, India, Brazil, Mexico and Malaysia are also fraught with risks. Most notably, these include political tensions, poor economic management and currency issues, inadequate infrastructures that can’t keep pace with the strong growth and a lack of decent research.

With international equities in the midst of a sell-off, much like the markets at home, now’s a good time to take a closer look at what lies ahead for three emerging markets in particular… and the one I like most.

The Turkish Transformation

A couple of weeks ago, I visited Turkey. And the changes in that country over the past five years have been nothing short of amazing. For example, Istanbul, where I stayed for a week, has radically transformed itself from a “kind of European city” to one on par with many other European cities. Okay, it hasn’t quite reached the “A-List,” like London and Paris, but it’s definitely in a league with places like Prague and Athens.

Upon arriving in Istanbul, an impressive, brand-new airport greets visitors. The city is clean, its hotels are excellent, monuments are striking and higher prices have moved Turkey out of the “massive bargain” realm of a few years ago.

By emerging market standards, Istanbul is an expensive city. In fact, were it not for my visit to China last year, I would have thought that prices were still very good. But a good meal that cost me $5 a few years ago now costs about $10. The markets and bazaars are busier than ever.

But therein lies the problem for countries like Turkey, India and a host of other emerging economies: They can’t compete with the world’s factories. In fact, many of the items for sale in Istanbul’s bazaars came in boxes marked “PRC” - the Peoples Republic of China.

The Sinking Stock Market In India

Besides Turkey, I’ve also embarked on a research trip to India over the past year.

Yes, India has changed markedly, but it’s still not close to being the juggernaut that China is today. Opportunities still exist, just not at current prices.

When I was in India in February, with colleagues James Boric and Greg Grillot, we all felt that the stock market did not reflect reality. I often remind readers that the entire market capitalization of the Bombay Stock Exchange is less than the market cap of the top-five U.S. companies. A close examination of the market revealed it was overdue for a fall - one that is now happening hard and fast.

From a 52-week high of 12,671 on May 11, the index has since plunged 22.5% in just one month. Indian papers are now even talking about the high possibility of investor suicides, as many have lost everything.

What about China?

The Best Emerging Market of the 21st Century

Undoubtedly, China is the best emerging market story of this century. But even that does not make it a good investment if you can’t withstand a lot of risk.

China is a major depressionary force for other emerging markets since it is the lowest-cost producer. That puts a cap on the prices of goods worldwide. It also puts a cap on profits from companies that operate in many sectors.

The best sectors for profiting in the Chinese Millennium: Infrastructure, aviation, commodities and finance.

Sectors to avoid: Manufacturing and retailing. Why? Because they are going to continue to witness margin pressure as the never-ending flow of goods pours from the Great Dragon.

Don’t get me wrong. I’m bullish on China. Just not today. Remember that China is an emerging market - and that means risk and lack of transparency. The financial system, for example, is nothing more than a house of cards. The banking system is a mess and the government hides most of the bad accounting from Western eyes.

I believe there will be a major shakeout for Chinese stocks. There has to be. And it will happen when the Chinese government decides to take the painful measure of coming clean in an S&L type of crisis. This will wipe out a lot of equity, but it will be the first real step forward for the Chinese market. And that is when I will be buying China.

Good Trading,

Karim

Today’s Smart Profits Cribsheet

I first alerted Smart Profits readers to the impending Indian market correction back in early March. Get the details on this emerging - but still very raw - market in Smart Profits #287, Emerging Markets: Two Plays in India…with Caution.
And around Christmas 2005, I told readers about one of the key economic issues today - and one contributing to the massive U.S. trade deficit: the abundance of cheap goods in China. Read all about it in Smart Profits #269: Emerging Markets: Forget the Great Wall of China - Let’s Go Shopping!

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