Geopolitical Warning: Should You Sell or Short Emerging Markets in 2016?

As an investor with over twenty years of experience, I have to confess that investing internationally still makes me nervous.

Globe emerging markets eemPart of the reason is that rules are different overseas, and I am more comfortable understanding the laws of how businesses can operate here than working with unfamiliar territories. With the exception of Canada, I could not tell you much about the ins and outs of securities laws overseas, and that makes me nervous.

While I’m sure there are many fabulous international companies that I’ve never heard of, it is difficult for me to assess too many of them because so much of my investing style relies on an understanding of human psychology.

Some of that comes down to cultural differences. It is why, for example, I doubt Starbucks (SBUX) will be successful in Italy. I happened to have been in Italy and know consumer behavior with coffee and cafés. That’s unusual.

Pundits say that emerging markets are the place to be, and they will provide lots of opportunity for growth going forward.

That may be true, but I’ve got other concerns.

One of the other problems I have with international markets is that there are always political crosscurrents I have no knowledge of that can affect stocks. That’s why, to be safe, when I do invest internationally, it’s usually only via ETFs.

International ETFs to Short

Now we have bigger problems in international markets, which makes me want to consider shorting them. The first is financial and the second is political.

As we know, Greece and Cyprus have blown up. So have Ireland and Spain and Portugal. There are several countries that are in big trouble on a debt-to-GDP basis. Singapore is at 98%, India at 61%, Hungary at 86%, Brazil at 64% and Japan is so far over 200% I don’t know where it stops. Emerging market corporate debt is on a big upward trajectory.

Eventually, it’s going to blow up, and I don’t want to be invested when it does. So I would sell or short SPDR S&P Emerging Markets Small Cap ETF (EWX). While it is very diversified, it is diversified among all the worst countries with debt issues. It’s also heavy on small-cap companies, which are all the more subject to volatility.

Now let’s look at politics. As I recently learned from a good friend who has done a lot of business in China, things are totally different over there. No matter how secure you think your business is with the Chinese government, he tells me it can all vanish in a second because they changed their minds about something. Or you inadvertently offended someone. Or a government official who just wants to keep his car, driver and apartment sees the unlikely chance that your product will offend a visiting dignitary in the middle of next year, so your product gets removed from shelves. Or maybe you get shut down for something having nothing to do with you. It’s all random, and I want nothing to do with that.

Thus, I would sell or short First Trust ISE Chindia ETF (FNI). Its top ten holdings account for 62% of assets and half are in China. SPDR S&P BRIC 40 ETF (BIK) is highly invested in China. No, thank you.

But there’s an even greater threat. From a geopolitical standpoint, radical Islam is spreading and it seems that there is little interest in preventing it. I’m not speaking about terrorism so much (although that’s one heck of a huge concern), but that fundamental religious governments aren’t exactly the best stewards of capitalism.

Take a look at this “Map of Freedom.” There are 107 countries listed at “not free” or “partly free.” I could not invest in countries in purple or yellow. Yes, that includes China, Russia and Egypt.

Maybe that’s why there’s been a trillion dollars in capital outflows over the past 16 months from emerging markets. In case you’re wondering why a Chinese firm bought out our AMC Theater chain, it’s almost certainly because Chinese nationals are trying to get their own money out of the country.

Bottom Line for Emerging Markets

So I would stay far away from emerging markets, and even consider shorting them, because things are only going to get worse. So I suggest you sell or short these as well:

iShares MSCI Frontier 100 (FM) – I want nothing to do with stocks from Kuwait, Nigeria, Argentina or the other countries that account for the top ten holdings, which make up 34% of the asset base.

SPDR S&P Emerging Middle East & Africa ETF (GAF). As a foreign mutual fund manager once told me, and she’s an expert in African companies, “don’t put a dime into any African company unless you personally visit it.”

Market Vectors Gulf States Index ETF (MES). ISIS is out of control and killing Muslims as well as Westerners. If they decide they want oil, all bets are off.

I would do the same with any ETF that has the name “China” or “Russia” in its name, or the name of any country in yellow or purple on the map.

Lawrence Meyers has no position in any security mentioned, but may initiate a position in one of the named or referenced securities in the next 90 days.

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