I have lived in them, worked in them and have relations in several of them. I am a fan, but
beware of fans as they have a habit of following fashions. The emerging and developing nations
have quite understandably been the darling of investors for some time. Obviously this is quite
understandable given the stunning growth stories that we have seen in many of these nations.
Compared to our old stodgy developed economies these are exciting areas with higher growth
rates than we are used to, as well as younger populations often with a more positive and
dynamic attitude. Additionally such countries are often under-represented in the global market.

Figures from Goldman Sachs indicate that total capitalisation of the emerging markets could rise
from the current level of $14trn to some $80trn by 2030. This would be an increase in the global
total value from 31% to 55%. Allowing for a level of new issuance, this translates into an
annualised return of 9.3% compared to a seemingly sluggish 4% from the developed markets. So
that seems to be an obvious decision then – a dead cert!

As soon as you hear those words I hope an alarm goes off in your head.

Thus before you commit all your investments to these ‘sure fire winners’, please may I add some
suitably realistic words of caution? In the years from 1991 to 2000 the emerging markets
delivered a total return of 38%: the developed markets delivered a return of 171%. However, to
be fair, it has been in the past decade that the emerging markets have really performed by
quadrupling investors’ monies.

So this is a warning which applies to all economies, but it is especially clear with the developing
ones, in that the correlation between economic growth and the rise in share valuations is by no
means direct. This can be often for quite logical reasons – for example many growing companies
are often private and those that are locally listed may often be more mature ones which may
well be growing more slowly. Also it is not uncommon to find that local markets are dominated
by one sector or company type – like the US markets in the 1900’s being heavily weighted
towards railroad companies, or Malaysia in the 1980’s dominated by plantation companies.

So are we seeing another bubble develop as desperate Western investors search for anything
better than their own tired economies? Emerging market funds have attracted some $45bn this
year already. Euphoria always has to be followed by some level of disappointment and thus
there will be peaks and troughs, as areas of the Asian property market have already illustrated.
However, these economies are broadening out from just ‘one horse’ commodity bets, as can be
seen by the breadth and depth of consumer expenditure and the rise of the oriental middle
class. So the question is - are there bubbles? And the answer is yes, floating on the surface of
the water, but beneath them the economic tidal water is rising anyway.

                                                                   ***

I am finding it very difficult at the moment. One day good news and the next day bad news. So
why am I worried?

Two things concerned me last week (and it may become three if the US unemployment figures
are worse than expected). Firstly, the continuing rhetoric out of the US about currency
manipulation and their attitude towards China, although I find it mildly amusing when such
comments are made as I cannot think of any circumstance when a nation does not try to
influence the value of its currency to its own benefit. The possible exceptions to that are some
of the more unfortunate members of the Eurozone who are locked into to a mechanism
dominated by the larger members.

To this I can add the concerns over the so called ‘currency wars’. This is an overly dramatic term
made up by the media to hype the arguments over currency values. Yes there are distortions -
especially with the Chinese reserves and the German export focus, and the pressures on
countries like Brazil who have seen their currency rocket are very significant. At the time of
writing the IMF meeting is yet to be held, but this subject is going to be high on the agenda.
Unfortunately these issues are not going to be solved in open forum, but it is going to be private
briefings that will affect any change. The lynchpin is of course the Chinese view. Chinese Premier
Wen Jiabao has warned of political stresses domestically if the currency rises and puts pressures
on domestic factories with thin margins ‘if China saw social and economic turbulence then it
would be a disaster for the world’. This pushes the door ajar on the social pressures in Chinese
cities and especially with the rural migrant population. It may also be a reflection on the
Premier’s own position and some of the hardliners who may well consider their leader as having
been already too flexible. This makes Kremlin watching look simple in comparison.

The second issue for concern was regarding the Institute of Supply Managers (ISM)
manufacturing new orders index. This is usually a very credible forward indicator of what is happening in the economy and after some positive few months it appears to have sharply
turned down again. The particularly worrying measure is that almost without exception,
whenever the measure for inventories (stocks) exceeds the measure for new orders, a recession
is likely to follow soon after. Looking at the overall ISM index you will find that the figure is still
above the 50 point level which is the dividing line between expansion and contraction, but if the
inventory level was to fall further, then this could be an unpleasant harbinger of the next
recession.
   

                                                                     ***

And finally.................a cutting from a US newspaper that requires no comment.

Bradenton, Florida - When sheriff's deputies allegedly discovered bags of marijuana and cocaine
between a man's buttocks, they said he gave a quick explanation. Manatee County deputies said
Raymond Stanley Roberts told them "The white stuff is not mine, but the weed is."

Deputies stopped the 25-year-old on Wednesday in Bradenton for speeding. Officers said they
smelled marijuana and searched him. That's when they allegedly found a bag of marijuana
between Roberts' buttocks. Officers then discovered another bag in there; the report said it
contained 27 pieces of rock cocaine.

The Bradenton Herald reported Roberts was arrested for drug possession.

Ewww!

Have a good week.

Justin A. Urquhart Stewart
Director
Seven