Because investing in emerging markets has become a very popular subject, a closer analysis of how markets really “emerge” may be in order.
In many ways, stock market cycles closely resemble the human life cycle. First, stocks are in an embryonic stage. Then, when they reach adolescene, they grow very rapidly (bullish phase). During this stage, they are accident-prone (crashes).Later, markets mature, lose some of their energy and volatility, then become tired and finally die (bear markets).
Fortunately for stock markets, there is usually life after death. A new cycle begins that, like reincarnation, is very different in nature from the previous cycle.
This discussion focuses on the events that tend to occur and the symptoms that become apparent during the stages of emerging stock markets. These events and symptoms will show up in varying degrees, depending on each market’s peculiarities. Obviously, the more extreme they are, the more likely it is that it will be possible to identify which phase of the cycle the stock market is moving into.
• Long-lasting economic stagnation or slow contraction in real terms.
• Real per capita incomes are flat or have been falling for some years.
• Little capital spending, and international competitive position is deteriorating.
• Unstable political and social conditions (strikes, high inflation, continuous devaluations, terrorism, border conflicts, etc.)
• Corporate profits are depressed.
• No foreign direct or portfolio investments.
• Capital flight.
• Little tourism (unsafe)
• Hotel occupancy is only 30%, and no new hotels have been built for several years. Hotels are run down.
• Curfews at night.
• Little volume on the stock exchange.
• Stock market has been moving sideways or moderately down for several years.
• In real terms, stocks have been ridiculously undervalued.
• No foreign fund manager visits the country.
• Headlines in the press are negative.
• No foreign brokers have established an office, no country funds are launched, and no brokerage research reports have been published for a long time.
• The social, political and economic conditions begin to improve (new government, new economic policies, external factors, discoveries, the rise in price of an important commodity).
• Improvement in liquidity because of an increase in exports, the repatriation of capital and increasing foreign direct and indirect investments.
• The outlook for future profit opportunities improve significantly.
• Increase in cash balance and wealth.
• Consumption, capital spending, corporate profits and stocks begins to rise sharply.
• Stocks suddenly begin to pick up.
• Tourism improves.
• Foreign businessmen become interested in joint ventures and other direct investments.
• Hotel occupancy rises to 70%.
• A few foreign fund managers begin to invest.
• Curfews are lifted.
• Tax laws are changed to encourage capital formation and to attract foreign investors.
• Unemployment falls and wages rise.
• Capital spending in order to expand capacity soars, as the improvement in economic conditions is perceived to last forever (error of optimism).
• Large inflows of foreign funds propel stocks to overvaluation.
• Credit expands rapidly, leading to a sharp rise in real and financial assets.
• Real-estate prices rise several-fold.
• New issues of stocks and bonds reach peak levels.
• Inflation accelerates and interest rates begin...