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Emerging Market Tide Has Changed

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Recent sentiment, specifically in regards to emerging markets and emerging market equities, has shifted.

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Third, and this, I think, is mostly a subjective problem, what's apparent in looking at the stocks that most investors use to invest in emerging markets-and we're talking about some really, large stocks here, with a market cap of $181 billion for China Construction Bank (OTCMKTS:CICHY) and $71 billion for Vale - is that they, for the most part, represent a specific model of economic growth, one that is based on commodities, and exports, and investment-led growth. I think what we're seeing now in major developing economies isn't just a slowdown, but also a change from this export-led model for growth, to one that is more domestically focused and more consumer focused. If that's true, that's both an objective challenge to these economies - can they pull off this transition - and a subjective challenge to investors who are used to looking for their investment choices for these markets, to a group of stocks that is no longer leading stock market and economic performance in these countries. The subjective challenge is to avoid generalizing - the underperformance of Vale isn't an indication of underperformance for all of Brazil's economy - and to become familiar with a new set of stock names that includes the leaders of a new pattern of growth that emphasizes the domestic consumer.

To go back to my original question, so what do you do now?

I do think you need to recognize that the old export-driven, commodity names still haven't found a bottom. As long as China or Brazil, for example, are groping toward a new growth foundation, commodity-based, export-oriented stocks can't be said to have bottomed.

I think you need to recognize that, during this bottoming process, we aren't looking at a rising tide that lifts all boats. On the evidence of the last 12 months, it is possible to find domestic consumer stocks in emerging markets that do well, but these stories are the exception rather than the rule. Yes, Kroton Educacional (BVMF:KROT3) in Brazil is up 109.72% in the last 12 months or Tencent Holdings in China is up 57.20% in the last 12 months or Industrias Bachoco (NYSE:IBA) in Mexico is up 73.04%, but these stocks aren't typical of the performance of domestic consumer stocks in emerging markets. (More typical is the 12.85% drop in shares of Natura Cosmeticos (BVMF:NATU3) in Brazil or the 16.66% loss for Ping An Insurance (HKG:2318) in China.) Making money even in domestic consumer stocks in developing economies, when sentiment is so against these markets, is hard.

If my thesis about the shift in the economic models for these developing economies is correct, investors in these markets will have to learn a new set of stocks - and they'll have to figure out how to trade them in local markets, since relatively few developing economy domestic consumer stocks are listed in New York.

And finally, investors will have to keep in mind that while domestic consumer stocks may outperform the old export-driven stocks now, and while they may outperform them in the long run, when sentiment about emerging markets does turn, the biggest quick winners are likely to be the old, familiar, beaten-down exported-driven stocks. You may not want to own them for the long haul, but you surely will reap big returns if you can call the turn in sentiment.

At least that's how I'm thinking about investing in emerging markets for the next year or so.

Editor's Note: This article was written by Jim Jubak of MoneyShow.

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