The Callan Periodic Table of Investment Returns for various Emerging Market indices from 2006 to 2015 are shown in the chart below:

Click to enlarge

Source: Callan Associates

Emerging markets are hot this year with many markets having soared by double digit percentages so far. These markets were also the top performers before the Global Financial Crisis of 2008-09. The widely followed MSCI Emerging Markets Index rose by 32% and 39% in 2006 and 2007 respectively. However in more recent years emerging stocks have let down investors with their poor returns. In 2013, 2014 and 2015 emerging stocks as represented by the MSCI Emerging Markets Index lost money.

Investing in emerging markets is not suitable for all investors. Even investors who can stomach the gut-wrenching rides should allocate only a small portion of their assets to these markets. As in other markets, small caps get crushed more in market downturns than large caps. The FTSE Emerging Markets Small Cap Index (“FTSE Emerging SC” shown above in blue) crashed 63% in 2008.

Related ETF:

• iShares MSCI Emerging Markets ETF (EEM)
• Vanguard FTSE Emerging Markets ETF (VWO)

Disclosure: No Positions

Related: The Callan Periodic Table of Investment Returns 2016: A Review

China follows a unique form of political system called  “market socialism”. In this system, the economy is capitalist to some extent but the political system is communist. Under this system only one party runs the country and no other party is allowed to exist. The state plays a major role in the functioning of the economy. Individuals are given limited freedom to open and run their enterprises and become wealthy in the process if they are successful. The state ensures that the key industries are controlled by the government and the state does not believe in the “markets” and its “invisible hands”. Because political control remains under the firm of the communist party individuals regardless of wealth are basically forced to keep quiet whether they agree with or disagree anything the state does.

On the other hand in countries such as the US that follow capitalism, democracy exists and individuals are allowed full freedom to do anything they wish as long as it is legal. No law prevents anyone from starting a new political party for example or citizens will be crushed by tanks should they protest some actions by the state. In this political system, the state trusts in the “market” and its “invisible hands” to run the economy. The state plays a small role in ensuring laws and regulations are set for participants in the market follow and punish violators. In some ways the state plays the role of a spectator in a show as opposed to someone who actually runs the show.The state also believes that the worst of human beings in a competitive economy will do the best for others and the country. This type of assumption overlooks natural human sins such as greed/lust for wealth and power. The concept of “trickle down economics” is also widely believed and supported. This concept simply means that once some individuals become extremely wealthy due to their hard work and luck, they will start investing their wealth in creating jobs, building factories, etc. to help others who are lower in the economic class system.

With that introduction to two forms of political systems, here is an excerpt from an article by professor John Ross:

China’s ‘socialist development strategy,’ which commenced with its 1978 economic reforms, is radically different in its entire framework and directly counterposed on key policy issues. China used, in Xi Jinping’s phraseology on economic policy, both the ‘visible’ and the ‘invisible hand’ – not simply the private sector but also the state. Indeed, in China itself, as the 3rd Plenum of the Central Committee of the 18th Congress of the CPC insisted: ‘We must unswervingly consolidate and develop the public economy, persist in the dominant position of public ownership, give full play to the leading role of the state-owned sector.’

In social policy, accompanying the economic dominance of the state sector, China did not rely on ‘trickle down’ but, in line with its socialist approach, China:

• undertook massive and conscious programmes deliberately aimed at eradicating poverty – these are to be completed in the 13^th Five Year Plan by 2020 by lifting the remaining 70 million people out of poverty;
• China deliberately promotes development through urbanisation as a way of moving the population into higher productivity economic sectors;
• China deliberately sought to narrow the income gap between rural and urban areas;
• China does not rely exclusively on ‘the market’ but deliberately uses state infrastructure spending to raise the economic level of its less developed inland provinces;
• legally China guaranteed private property but a key economic role was assigned to the state sector,
• politically China was socialist.

What, therefore, were the factual outcomes of these two radically different approaches to economic development? To assess this, for reasons which will become evident from the statistics, not only will China itself be analysed but three other countries will be considered. These are Vietnam, which defines itself as socialist and which in reality drew heavily from China’s ‘socialist market economy’ approach, Cambodia, and the Lao People’s Democratic Republic – the latter two also being highly influenced by China’s development model.

The facts are summarised in Table 1 which shows the annual average rate of per capita GDP growth up to 2015 from 1978, when China began its economic reforms, from 1989, when the Washington Consensus was put forward, and from 1993 when data for Cambodia becomes available.

The data is of course extremely striking – indeed conclusive. From 1993-2015, when all four countries can be analysed China, Cambodia, Vietnam and Laos ranked respectively 1^st, 2^nd 3^rd, and 4^th in world per capita GDP growth – peripheral cases of countries with populations of less than 5 million or dominated by oil production are not included. From 1989, the date of the putting forward of the Washington Consensus, to 2015 China, Vietnam and Laos ranked respectively 1^st, 2^nd and 3^rd in the world for countries in per capita GDP growth. From 1978 onwards China ranked 1^st among all economies in terms of economic growth.

This ranking of growth necessarily shows that China’s economic model not only produced more rapid growth than developed economies but also capitalist economies at the same stage of economic development (level of per capita GDP).

Table 1

Source: Data shows China’s ‘socialist development model’ outperformed capitalist development strategies, John Ross, Senior Fellow at Chongyang Institute for Financial Studies, Renmin University of China, Key Trends in Globalisation

Dr. Ross’ point about eradication of poverty is surprising. He notes (emphasis added):

From 1981 China lifted 728 million people out of World Bank defined poverty. Another socialist country, Vietnam, lifted over 30 million from poverty by the same criteria. The whole of the rest of the world, in which the dominant model advocated by the IMF was the Washington Consensus, lifted only slightly 120 million people out of poverty.

The entire article is worth a read.

You may also want to the following related story in the NY Times.

From Venture Communism: How China Is Building a Start-Up Boom:

The Chinese Communist Party doesn’t trust the invisible hand of capitalism alone to encourage entrepreneurship, especially since it is a big part of the leadership’s strategy to reshape the sagging economy.

Global investors used to consider emerging market as mainly commodity plays. Unlike developed markets other sectors such as banking, healthcare, IT, consumer staples, telecom, airlines, etc. did not get much attention from most investors. But today’s emerging countries are much more than just commodities, For instance, the Chilean economy is not confined to just copper, the Russian economy is more than just oil and gas, China is turning into a consumption-based economy, Mexico is a manufacturing leader than only an oil producer, etc. So investors looking to add exposure to emerging markets should cast their net wide and consider these markets for all types of sectors than only commodities.

From an interesting article on Emerging Markets by Merryn Somerset Webb at MoneyWeek:

In Latin America, Chile, Peru, Columbia and Brazil are making the right noises, while in Asia there are standouts such as Vietnam and Indonesia. For now, at least, says a note from Eurasia Group, there is a “positive inflection point in emerging market political stability”. But the convergence – and hence the argument for the disappearance of the emerging-market discount isn’t just about politics (obviously). It is also about structural shifts in the economic make-up of various countries.

Thirty years ago, emerging markets were all about commodities and cyclical investments. No more. According to Ashmore Investment Management, some 50% of the MSCI Emerging Market index is now made up of “structural growth drivers” such as telecoms, technology, consumer and healthcare companies. Overall, the tech share of emerging markets is higher than that of the S&P 500 (23% vs 21%). The commodity component has fallen to a mere 14% – less than half of what it was a decade ago.

The equity universe in emerging markets is broader, deeper and hence much safer than investors think. That makes it too cheap. Structural growth companies “have superior earnings visibility for multiple years compared to cyclical ones”, says Ashmore, so investors should be paying up for them. One day they will. They might also soon be willing to pay up for income – the one thing you all tell me over and over again that you want more of.

Big companies in the West are close to the end of the dividend road: in the UK, ten FTSE 100 stocks account for 55% of the income – and their payout ratios are far too high for comfort. Across emerging markets, things are different. According to Invesco Perpetual, there is a much higher degree of “dividend diversification” in the market (95% of firms in the MSCI Asia Pacific ex Japan index pay out something) and with good earnings growth, robust cash flow, healthy balance sheets and payout ratios that are currently low, the most obvious direction for dividend payouts is up.

Source: Buy into emerging markets as they turn into developed markets, MoneyWeek

Some of the emerging market equities that investors can research further include: Empresa Nacional de Electricidad SA (EOC), Ultrapar Participacoes SA (UGP), HDFC Bank Ltd (HDB), PetroChina Co Ltd (PTR), Standard Bank Group (SGBLY), etc.

Disclosure: No Positiosn