Emerging Markets on Fire

Buy Ideas:
iShares MSCI Emerging Markets Index (EEM)
ProShares Ultra MSCI Emerging Markets (EET)

Last week, my friend Angelina, a leggy brunette and one of the world’s top hedge fund marketing gurus, was briefly back in London from her tax exile in Monaco. She called to invite me to a book launch party for “The Gathering Storm,” edited by Lee Robinson and Patrick Young. The book features a collection of essays on the global financial crisis by big-name hedge fund types. Of course, I said yes, as exclusive parties in the Mayfair section of London allow me to mingle and meet with the great and the good of the financial world, ranging from Goldman Sachs partners to the top traders at the world’s biggest hedge funds. And the insights from lively discussions with these otherwise publicity-shy Masters of the Universe over a glass of Veuve Clicquot champagne also have made both my subscribers and investors a lot of money.

High on the list of topics for these Mayfair millionaires was plotting their escape to Switzerland from the United Kingdom’s onerous tax system. But we also spent time swapping investment ideas, and the two words on everyone’s lips were “emerging markets.”

That did not surprise me. I’ve always felt that emerging markets were the place to be in the last quarter of the year. After all, when I was sitting on $1 billion-plus a decade or so ago, this was the time of year when we’d get together with my partners and — often over a “boozy” lunch — decide where we were going to place our bets on the planet in the coming year. That same process — repeated in Tokyo, San Francisco, New York and elsewhere — always gave global stocks a big boost in the last quarter of the year. That’s why it seems anything that I’ve recommended to my subscribers in emerging markets since late summer has shot straight up.

I managed to corner one prosperous-looking Swiss “hedgie,” sporting a pair of über-fashionable, square-rimmed glasses. Let’s call him the “gnome of Zurich.” In his clipped Swiss accent, he made his case for emerging markets. Unlike back in the 1990s, emerging markets today have debt-to-GDP ratios and budget deficits that put profligate, champagne-swilling Westerners like him to shame. And that doesn’t even account for the rainy-day fund they have in the form of $5 trillion in foreign-exchange reserves. No wonder emerging-market, equity-fund inflows hit a 33-month high of more than $6 billion just the previous week.

But there was one piece of news that the gnome was almost euphoric about — the one thing that he thought just might help him earn a bonus big enough in 2010 to buy that red Ferrari he’s had his eye on. Fed Chairman Ben Bernanke, running printing presses overtime for the U.S. dollar, has sparked a fire under emerging markets. And that, to the gnome, could mean nothing but blue skies ahead, as far as the eye can see.

Frankly, all of this boozy optimism has me a bit worried. The sovereign debt of Indonesia, a market I’ve long recommended in Global Stock Investor, now is barely considered riskier than that of boring old Belgium. Mexico, yes, the country that has claimed the lives of 29,000 people in a drug war just since 2005, recently issued 100-year bonds. If you have a hard time imagining what Mexico will look like in 2110, consider that 100 years ago, William Howard Taft was U.S. President, TV and penicillin had not yet been invented, and the globe had two world wars ahead of it.

Having lived through at least four emerging market booms and busts over the past 20 years, I agree with the gnome that investors are set to make a lot of money in emerging markets between now and the end of the year. I’m also sure that Ben Bernanke’s bubble-blowing experiment will end in tears… but just not yet.

Buttressing the gnome’s position, I pointed out that the MSCI Emerging Markets Index has more than doubled from its bear-market nadir in October 2008. The Chinese market alone would have to double to get back to where it was in 2007. But unlike, say, in the U.S. bond market, I’m not seeing silly valuations typical of a bubble. The MSCI Emerging Markets Index is on a forward price/earnings multiple of 11 — less than its 20-year average of 13.7. And earnings in the MSCI Emerging Markets Index will increase 28% in the next 12 months. That makes emerging markets a steal.

Upon hearing my onslaught of statistics, the gnome’s attention quickly wavered. He gave me a knowing smile, and slid past me to turn his attention to Anastasia, a Russian temptress of uncertain means, who had been ogling him from the other end of the bar.

As he left, he turned back and said, “My friend. Here’s a toast to your countryman, Mr. Bernanke. The end may be nigh. But for now, it’s time to party like it’s 1999.”

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