Hitting the ceiling in emerging markets?

The great industrialist Henry Ford famously saved the bulk of his fortune from a Great Depression swoon by listening to an elevator operator just prior to Black Thursday in 1929.

The handle-puller told Ford that the car-making baron should buy more equities because the New York stock market would only keep soaring skywards.

Ford thanked the gentleman, exited the lift and immediately told his broker to dump all holdings.

Ford’s theory: If the guy working the elevator thinks you should buy, you should sell.

In recent months, investment gurus have been touting the virtues of emerging economies. Indeed, in recent months, seminars and talks on these new-growth markets have sprouted up like dandelions.

Since the beginning of October alone, U.K.-based Aberdeen Asset Management held a major conference on emerging markets, and other groups had planned at least three seminars on investing in Africa.

The Reuters news agency likened the trend to an asset bubble.

“The ratings agency Finch ... held a seminar on Africa, as its regular emerging markets conferences couldn’t deal with demand,” reported Reuters in October.

It is this exuberance that should signal to investors to watch their step.

“I don’t think the sun has set on the developing markets — just that returns will be lower than in the past,” said Michael Herring, an investment strategist with BMO Nesbitt Burns.

In 2009, sticking your equity allocation in countries, such as Vietnam, India and China, might have led to higher returns in the face of economic uncertainty in North America and Europe.

After all, while North American stock markets began to gain altitude in the middle part of that year, few experts saw economic data to reinforce this optimism.

In fact, North America’s economies shrank by three per cent in 2009, according to the International Monetary Fund.

By contrast, newly developing regions were on the rise.

China’s gross domestic product (GDP) grew by 10.5 per cent in 2009 while India enjoyed an expansion rate of 9.7 per cent.

Even Africa’s lowest-income countries — a group not usually associated with booming economies — posted ‘09 GDP growth of 4.5 per cent.

These better economic results were reflected in the soaring equity markets.

India’s Sensex index jumped almost 80 per cent in 2009, hitting almost 17,500 points in January 2010, versus a reading of about 9,750 a year earlier.

Similarly, South Africa’s FTSE/JSE All-Africa index tumbled to a mid-2009 low in the range of 18,000 before soaring to about 26,000 in the next year, a 44-per-cent gain.

This year will find it tougher slogging for emerging markets. But not because those economies are ripe for a slump.

The IMF predicts China will grow by about 9.5 per cent in each of the next two years.

Vietnam is expected to see economic expansion of 6.8 per cent in 2010 and 7.5 per cent in 2011. Even Bangladesh, again a country not usually associated with stellar expansion prospects, has economists forecasting average GDP growth of more than 6.5 per cent into 2011.

“Macroeconomic indicators suggest the 2010 growth outlook for developing Asia is stronger than anticipated,” said the Asian Development Bank in a July note on the regional economy.

The investment problem for the newly developed countries, however, is two-fold.

First, the economies of North America and Europe look to be entering a mild growth phase.

For example, Canada is forecast to grow at 3.1 per cent for 2010 and 2.7 per cent in 2011, while the United States should enjoy a GDP expansion rate of 2.6 per cent and 2.3 per cent for ‘10 and ‘11, respectively.

So, a greater number of risk-adverse investors probably will seek the shelter of these traditionally more stable economies.

In addition, high-growth stock markets often have difficulties matching pervious expansion rates, partly because investor optimism has already been injected into stock valuations.

Remember the Indian index?

What was an 80 per cent return in 2009 has been chopped to 15 per cent so far in 2010.

The Indian economy is still chugging along. But investors have already anticipated a large portion of that growth, translated into profit and potential corporate gains.

In the end, the ceiling might already be in place on gains from investing in emerging markets.

“People have been talking about emerging markets for 20 years. Meanwhile, these countries have been, well, emerging,” Herring says.

Things to remember

 • Investing in emerging markets has fared well in recent years.

 • These markets might be set for a slowdown.

 • High equity growth always gives way to moderation.