The BRICs — that’s Brazil, Russia, India and China — all had a rough go in 2013, with all four regions finishing the year deeply in the red despite a roaring 30% gain for U.S. stocks last year. Their individual troubles became collective ones, then spread to smaller emerging markets and less developed frontier markets, too.
Consider China’s troubles weighing on commodity prices — and thus exports from mineral-rich nations across Africa, South America and the Pacific — as the prime example.
Or beyond the obvious, consider the scary analogy recently drawn between an embattled Chinese lender and Bear Stearns, and the fears of credit contagion as risky debt products have plunged in value and other institutions might need bailouts to stay solvent. The problems with debt and leverage in China could spread not only across this nation, but to related EM countries like Chile and Peru that have close financial ties to the Asian powerhouse and suffer credit risks themselves if things go south.
And just to throw gasoline on the fire, political unrest is a constant wild card.
I’m not just talking about the “desperate struggle” in the Ukraine that has dominated headlines, either. Ukraine’s strife was born in part out of financial struggles and a lack of economic opportunity … and that narrative could easily play itself out in other nations.
The nightmare scenario for an emerging market is economic collapse that is quickly followed by a political collapse. And any investor holding the bag will see serious losses as a result.
These kind of meltdowns are admittedly rare, but they do happen … and EM investors need to always keep that in mind. Because while emerging-market stocks frequently have big growth potential, they also come with big risks.
Bottom Line: Be Discerning and Patient
I remain convinced that while there are big risks in China, this region is the tail that wags the dog and that if you believe in EM investing at all, you have to start with this mega-player instead of hoping naively that related economies in Asia or South America will thrive without a Chinese recovery.
I also think it’s worth noting that The New York Times just coined a new term to supplant BRICs and PIGS as the global fun club du jour — the “Fragile Five” that consists of South Africa, Turkey, India, Indonesia and Brazil. These regions are clearly some of the hardest-hit right now, as is Argentina as it teeters on default.
My friend Ed Elfenbein probably said it best lately when he urged investors not to paint all emerging markets with a broad brush. He wrote:
“I don’t know where all these recent EM developments are headed, but we’re going to soon find out who’s been responsible and who hasn’t. Mexico, for example, will probably pull through just fine. Poland as well. But I’m not so sure about others. Until then, we can expect a little more volatility in our markets and a lot more in the emerging markets.”
In other words, be patient and pay attention. Some regions are better than others, and this has to shake out for a bit longer before we will be able to separate the wheat from the chaff.
That’s not very satisfying, but it’s the truth.
Jeff Reeves is the editor of InvestorPlace.com and the author of The Frugal Investor’s Guide to Finding Great Stocks. As of this writing, he did not hold a position in any of the aforementioned securities. Write him at email@example.com or follow him on Twitter via @JeffReevesIP.