Sunday, February 5, 2012

Beware of Future Crowding in US, Emerging and Frontier Markets


The purpose of my blogs is to share musings as how to grapple with long-term investing as distinct from shorter-term trading. Most of the time my focus is endowment-type thinking, be it for my family or supposedly perpetual institutions that have some near-term funding requirements but whose main focus is to maintain the organization forever.

Bearing the above preamble, instead of my normal optimistic views, on a longer-term basis I am getting nervous. This anxiety could be caused by the fact that I am finding too many thoughtful investors have parallel views.

The US Markets

As regular readers of these blogs have learned, I have believed that there was more upside potential than downside risk. Since the beginning of the year we have seen currencies, bonds and stock prices rise. As somewhat expected, the general rise has been led by financials and smaller companies. Much of these moves are recoveries from past declines, nevertheless the following three facts are unnerving for someone not used to so much good market news all at once:

  • The S & P SmallCap 600 index reached an all time new high.

  • The NASDAQ index is at a 11 year high. (Still way below its former peak.)

  • The Dow Jones Industrial Average has risen more than it has in the last 4 years.

These price movements are beginning to attract volume and many politically motivated people are becoming bullish. My problem with all of this is if one extrapolates the January gains achieved in some portfolios, one could start to hear about certain managers delivering at a 100%+ rate! My instinct is that this enthusiastic response will be met with a sudden and sharp decline. If the decline reaches 10% or more, it may allow the late-comers to participate.

Emerging Markets/Frontier Markets

Over the last couple weeks I have been focused on Emerging Markets and Frontier Markets, talking with a number of portfolio managers that have successfully invested in these two markets for many years. What is disconcerting to me is that I am hearing the same comments about various markets which can be summarized below:

  • It will take a long time for corruption in India to subside to the level of other Asian counties.

  • China is a mixed picture of large long-term consumer demand, but with near-term infrastructure hurdles and capital flight, some earned through corrupt practices. The two unanswered questions are when will there be sufficient east-west road and rail traffic to bring a rise in the standard of living to the hinterland cities, and whether the all-controlling government will continue to succeed.

  • Smaller markets are attracting a good bit of interest; e.g., Indonesia is coming into its own with Western firms establishing offices there. The lowering of the high interest rates and the return to investment grade after many years of "junk" grade has been a big boost. There appears to be a short supply of stocks relative to demand.

  • Africa is definitely of interest, with investments going into Ghana and Nigeria. Even local banks are of interest.

The fuel for these markets is coming from Europeans trying to escape the euro and the wealthy Chinese who are quite desperate to get money out of China. There are also negative reasons to invest in these markets; beware that exiting can be more difficult than entering. With all this enthusiasm, caution should be exercised.

Except for the real long-term investor, I would wait for better entry points that are less crowded.

Did you miss Mike Lipper’s Blog last week? Click here to read.

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