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While U.S. investors have been preoccupied with corporate profits and the possibility of rising interest rates, they may have missed some international developments that could affect their portfolio -- and not in a good way.
Last week's column underscored the nervousness gripping U.S. investors over the last several weeks. Unfortunately, the rest of the world picture might be even scarier.
We've been inundated with stories out of the Middle East as the Israeli-Palestinian conflict continues to escalate. The unrest and uncertainty in Iraq grows more worrisome everyday, and crude oil prices above $41 per barrel are making investors and consumers uneasy. Add to the mix the political turmoil in one of the emerging market darlings, India, and the potential for an economic slowdown in China, and you have the ingredients for international financial turmoil not seen since the days of the Russian currency crisis and the Asian Contagion caused by the 1997 collapse of Thailand's currency, the bhat.
Now even the stalwarts among Asia's developing countries have financial markets trembling. The potential for a stable, democratic government committed to free and open markets is a prerequisite if capitalism is to survive and thrive, but China and India have had a checkered past with regard to free markets. Recent events have some observers wondering if they're about to take a step back.
India's embrace of market reforms and its corresponding economic growth have made that country a haven for investment capital. Productivity has increased and outsourcing from Europe and the United States has lifted India's per-capita income, leading to a pick up in consumption by its upwardly mobile citizens. But last week's election of a left-leaning coalition government that relies on Communist parties for support has rattled that India's stock market; on Monday its main stock market average, which was one of the top performing global indices last year, fell more than 15 percent, the largest drop in the 129-year history of the Indian index. Investors fear that the new government will slow down privatization of state-owned companies.
China over the last 15 years has been a magnet for international capital, thanks in part to its huge growth potential, which had offset concern over government interference. With 1.3 billion citizens, China is the world's most populous nation, and as it moves into the pivotal role of a regional economic engine, demand for everything has increased. Investment in housing and factories has exploded, creating the conditions that could cause a bubble as fly-by-night projects battle with viable ideas for financing. More established capitalist nations like the United States typically rely on interest rates and currency movements to smooth things out, but China has gone back to administrative dictates to slow its red-hot economy. It raises fears of government interference in its burgeoning free market process.
These developments in the world's two most populous nations have had a cascading effect. Shares of state-controlled Chinese companies listed in Hong Kong fell 5.4 percent on Monday, leaving that index down more than 30 percent for the year. Taiwan's market shed over 5 percent to hit its lowest level since October, when China warned that it would thwart any move toward independence. Thailand - one of the world's best performing economies last year - fell nearly 5 percent. Even Japan, considered a larger market with a more stable economy, saw the Nikkei decline by 3 percent. At least in Asia, fear has overtaken greed as the dominant investor emotion.
That's a big problem for U.S. investors with emerging market exposure. While they want to reduce their foreign equity holdings, American investors in Asia don't want to buy, leaving a severe supply/demand imbalance that created the latest volatility. That has increased risk, forcing an exodus of capital from emerging market funds. According to EmergingPortfolio.com Fund Research, dedicated emerging market stock funds have lost more than $3 billion over the last three weeks.
Latin America isn't immune from the exodus. Funds specializing in Central and South America were the biggest losers in percentage terms for the week.
And you'll find no safe haven in Europe. After pumping record amounts of money into European stock funds for the better part of this year, investors are reconsidering the implications of a newly enlarged European Union.
In the wake of the widespread global uncertainty, many professional money managers are urging a more conservative approach. Wachovia has advised conservative investors to get out of emerging market investments. Bank of America Capital Management says focus on large quality multinational firms based overseas in lieu of emerging markets. Classic defense plays include investing in companies that benefit from inflation, those companies that can raise prices as inflation builds.
Of course, a contrarian would argue that global disruption makes this a time to buy, because emerging market fundamentals are the best they've been in a long time.
Whichever school of thought to which you subscribe, this much is certain: geopolitical events will continue to dictate international markets.
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