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Williamstown, MA, United States, 2006/04/10 - The iShares MSCI Emerging Markets Index ETF, which represents 26 markets from China to Hungary to Chile, gained more than 200% between its April, 2003 inception and early April, 2006.
The word “emerging” is too tame to describe the performance of emerging markets during recent years—“exploding” is more like it. The iShares MSCI Emerging Markets Index ETF, which represents 26 markets from China to Hungary to Chile, gained more than 200% between its April, 2003 inception and early April, 2006. Some markets performed far better. Brazil led the charge: The iShares MSCI Brazil Index ETF surged an astonishing 393% during the three years through April 10.
Thursday's most active stocks included: Lucent Technologies (NYSE: LU), Nortel Networks (NYSE: NT), Pfizer (NYSE: PFE), Time Warner (NYSE: TMX), iShares Japan Index Fund (AMEX: EWJ), General Electric (NYSE: GE), iShare Russell 2000 Index (AMEX: IWM), and Energy Select SPDR (AMEX: XLE).
A confluence of factors helps explain the emerging-markets rally. Economies in many developing countries have grown by leaps and bounds in recent years, as the US and other developed economies increasingly take advantage of lower labor and other costs in developing markets to outsource manufacturing, technology and service work. The rapid expansion of manufacturing in countries such as China and India also has boosted global demand for basic materials such as metals, wood and oil—items that remote parts of the globe have in abundance. And strong economies have boosted many countries’ currencies relative to the dollar, increasing returns for American investors.
Portfolio theorists have said for years that most investors should keep a small allocation to emerging markets. That’s partly because economies in emerging markets offer potential long-term growth that dwarfs growth in the mature markets of the U.S., Japan and western Europe: Goldman Sachs reported in 2003 that by 2039 the combined GDPs of Brazil, Russia, India and China are likely to exceed those of the US, Japan, the UK, Germany, France and Italy. (Such a development wouldn’t be unprecedented: China and India accounted for about 50% of global GDP in the early 1800s.)
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That kind of economic expansion will make the people in those countries wealthier, producing large new groups of consumers that both new and existing companies can tap to generate powerful earnings growth—which likely will lead to strong long-term stock performance. What’s more, economic development and maturing financial institutions and systems are likely to improve the quality and reliability of corporate finances in emerging markets. Higher quality accounting and reporting should convince worldwide investors to reduce the risk premium they demand for investing in developing markets, and that development also should support higher stock prices.
The potential for big gains isn’t the only reason to invest in emerging markets. Such far-flung investments typically have a low correlation to markets in the US and other developed countries, making them effective tools for diversification. For example, the iShares MSCI South Korea Index ETF gained a total of 50% during 2001 and 2002, while the Standard & Poor’s 500 lost more than 30%.
But while there are some good reasons to invest in emerging markets, there are equally compelling reasons to do so cautiously. Emerging markets can be extremely volatile. For example, iShares Brazil’s latest surge might cause investors to forget that the fund lost more than 60% between the beginning of 2001 and September of 2002.
One reason for emerging markets’ volatility: Such markets often exist in countries with weak financial or political systems, which occasionally suffer instability that can roil stocks. Some investors may remember the fallout from Thailand’s 1997 currency devaluation, which set off a chain reaction that engulfed the region and sent several markets plummeting by more than 80%.
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