The market meltdown in China this year has caused many commentators to proclaim the end of Chinese economic growth.
Yet geopolitically, the United States is much weaker today than it was 20 years ago, unable to make headway even against a decrepit middle-sized power like Russia.
Just five years ago, the BRICS were symbols of future emerging market dominance; now all but one are in trouble and the BRICS concept has gone out of fashion.
For investors, the world is a confusing place. Fortunately, there are some principles that can help you navigate it.
Debt, Debt, and More Debt
Let’s start with what we know.
We had a massive financial crisis in 2008. The world’s authorities resorted to unconventional methods to manage it, and things failed to return to normal as fast as most people expected.
This left the world with huge imbalances. The United States, Japan, and most of Europe are still running unsustainable budget deficits and running up debt that promises to produce a lot of headaches down the road.
The Fed, the European Central Bank, the Bank of Japan, and the Bank of England have kept interest rates close to zero for nearly a decade (double that, in Japan’s case) and swollen their balance sheets to an extent previously thought impossible.
The world is more indebted than ever before.
Meanwhile, some stock and real estate markets are overinflated. The global economy staggers along at a growth rate below those of the last decade. While it hasn’t imploded, productivity growth in advanced economies is worryingly slow.
The list of symptoms shows the global economy is sick, but it doesn’t suggest a cure.
It does, however, suggest a sound approach to investing: buy those markets with low valuations, sound policies, low debt, and favorable (or at worst, neutral) trade balances.
Where to Invest
In such countries, there won’t be an internal financial crisis causing values to crash, nor an externally imposed financial crisis. With favorable trade balances, these countries can finance themselves domestically.
This combination of virtues isn’t often found. The United States, Britain, and Japan all fail in regards to debt. The U.S. and Britain also fail on balance of payments considerations. Both run large deficits, which would cause trouble in a credit crunch.
Of the European countries, Germany runs a massive balance of payments surplus and a modest budget surplus. It’s also well-run economically. So Germany is one possibility.
Sweden also has a large payments surplus and only a modest budget deficit, making it another possibility.
As far as rich countries outside of Europe, South Korea eminently qualifies on all three criteria, running a modest budget surplus and large payments surplus, as does Singapore, whose balance of payments surplus is gigantic and its budget deficit small.
Because of their poor balance of payments, Australia and Canada don’t quite qualify, though that’s partly the result of the recent downturn in commodities prices.
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Emerging markets generally have less of a budget problem. They can’t afford to run large deficits for very long, and they experience more growth. On the other hand, some emerging markets are truly poorly run, and you certainly wouldn’t want to risk your money there.
China has a huge debt problem, most of it incurred as “stimulus” in 2008-09, but its economic management is better than is sometimes assumed. The Chinese even appear to be inventing a new category of “supply-side Communism.”
Brazil is a mess due to massive government overspending that stretches back to the 1988 Constitution, which established a constitutional right to public sector pensions. (Illinois has a similar problem!)
Russia is a badly governed mess with insecure private property rights.
India would have possibilities, but massive government deficits and a moderate payments deficit mean it’s vulnerable to a global credit crunch.
The fifth of the BRICS, South Africa, suffers problems in all three areas.
Estonia runs a balance of payments and budget close to balance, and it’s also generally well run, but it’s a tiny country – there’s simply not much for American investors to buy there.
Peru is close to balancing its budget, but its balance of payments deficit is over 4% of GDP because of the commodities downturn.
Chile is less virtuous than it used to be, but with its Aa3 credit rating, it’s still the safest haven in Latin America.
But the best of the emerging markets – with growth estimated at above 6%, a balance of payments surplus, and only a modest budget deficit (less than 2% of GDP) – is the Philippines. The country has been very carefully run under President Benigno Aquino. The Philippines has an upcoming election in May, and luckily all candidates seem committed to sensible policies.
To buy a broad spread of investments in a particular country, you’re probably best buying that country’s ETF.
As Germany, South Korea, and the Philippines stand out as the most stable, I suggest looking at the iShares MSCI Germany ETF (EWG), the iShares MSCI South Korea Capped Index Fund (EWY), and the iShares MSCI Philippines ETF (EPHE).
All three are substantial (the iShares MSCI Philippines Fund ETF is the smallest at $250 million) and have relatively low expense ratios, well under 1% per annum.