Study Methodology

wpe4.gif (10738 bytes)Figure 27 shows a plot of a rank-order of stock market relative performance plotted against the differentiated weighted score. The relative performance was rank-ordered on a descending basis; i.e., the country with the highest relative performance was ranked 36.

Although there does appear to be some correlation between scores and historical performance, the data is very scattered Ė the correlation is weak. Examination of a number of the outlying data points indicates at least two explanations. First, the model does not adequately account for changes in the environment. Russia scored very low but has a high relative performance. Russia is undergoing massive changes; from not being free to political freedom, from a command economy to a market economy, introduction of public ownership of companies, etc. Brazil is another example. Brazil experienced many years of runaway inflation and continual currency revaluationís. It now has a strong economic policy in place, which seems to be arresting inflation and seems to have stabilized the currency. It has a strong relative performance in spite of a low score.

Second, the time periods over which the relative performance was measured were arbitrary and probably too short. Markets become overvalued and undervalued; the relative performance is highly sensitive to the specific starting and ending periods chosen. Japan had a low relative performance, but it historically has been a strong market. Singapore also had a poor relative showing in spite of being the top scoring country. The difficulty in using a longer period of time for this study is the short time that country mutual funds or WEBS have existed for many of the study countries. In addition many of the emerging markets nations have been formed or have had significant structural changes in the last decade.

National Characteristics

The leading industrial nations of Western Europe, the United States, Canada and Japan are leading for specific reasons:

They provide political freedom in which individuals can make decision and take action.
They have free market economies in which market forces guide decision making.
They have religions that encourage, or at least do not discourage, hard work in pursuit of materialism.
They allow people who prosper through entrepreneur activities or through hard work to keep a significant portion of their acquired wealth.
They have strong educational systems in which the entire population has the opportunity to participate.
They have large numbers of scientists and engineers and make significant investments in research and development.
They have a long history of industrialization.
The economies are stable so that individuals and businesses can plan and implement projects with long-term payoffs.
There is political stability with an orderly process for changes in political leadership.
There is low tolerance for corruption on the part of politicians, the political bureaucracy, or business.

Unfortunately most of the industrialized countries are not living up to their potentials. The GDP per capital growth rate is typically low indicating stagnant or declining standards of living. The governments are pursuing social reform and wealth redistribution at the expense of improved standard of living for those who chose to work hard, risk assets, or to take entrepreneurial risks.

The high profit potential in emerging country investments is mostly wishful thinking. These countries have not succeeded for a variety of reasons that are difficult to change:

People lack the political freedom or economic freedom to make decision to promote their well being and to act on these decisions.
The predominant religion discourages pursuit of material goals or restricts business activities.
Legal or administrative barriers exist to entrepreneurial activities.
People are not permitted to keep a just portion of the rewards of entrepreneurial activities or hard work.
Competitive education is lacking or is limited to a select class of individuals.
Participation in the economic system is restricted by some measure: class, caste, race, religion, or sex.
The currency is unstable.
The nationís wealth is lost due to military expenditures, ill-advised infrastructure investments, wealth redistribution, or usurpation on the part of the rulers.

The emerging market opportunities which do exist are those where one or more of these factors are changing and the nation otherwise has some significant advantage. Russia is changing its environment to one of political and economic freedom. It has many natural resources and a very educated population with many scientists and engineers. The Czech Republicís environment has changed to one of political and economic freedom. It has a long history as a leading industrialized nation relative to its peer group, again with an educated population with an entrepreneurial spirit and a moderate number of scientists and engineers. China is gradually moving towards more political and economic freedom. It has a 3500-year written history describing a culture of organization, education, and industriousness.

The outstanding emerging market successes, Singapore and Hong Kong, have established environments in which entrepreneurs could work, invest and reap huge rewards. There are few legal or administrative barriers. The rulers and bureaucracy operate without corruption. There is economic freedom. There are no investment restrictions on nonresidents. There are no exchange controls. Income taxes are moderate. There are no capital gains taxes.

Opportunities for Profit

As discussed above, I feel that the emerging market country opportunities exist where significant changes are happening and the country has significant advantages: Russia, the Czech Republic, and China.

Brazil is an example of a country where the change is less substantial and creates a shorter-term opportunity. The government seems to be succeeding in bringing a long-standing inflation problem under control. This will create some opportunities since business people will have the opportunity to borrow money and to implement projects with a longer-term payoff. In addition the price earnings multiple increase because investors can more reliably predict earnings and the risk of losing capital due to currency losses is diminished. However Brazilís potential is limited over the long term by other fundamental shortcomings.

Multinational companies have an advantage. The ability to reduce costs by shifting activities to those countries where costs are lowest and to take advantage of economies of scale by marketing globally will provide a significant advantage over companies without these advantages. These companies have the resources to acquire and implement the latest technologies. The multinational companies are hiring hordes of MBAís with the best and most recent training. These multinational companies will subsume firms producing and marketing within a single country. Those single country firms who have a significant franchise or market share within their countries will be attractive buyout candidates for the multinational firms.

Opportunities exist for domestic companies in countries with fast growing standards of living, i.e. high GDP per capita growth rates. Improving standards of living drive demand for new products. Domestic companies are in the position to be in touch with the needs and desires of their customers and to quickly respond to them. Growth also drives demand for improved infrastructure: telecommunications, electricity, gas, roads, water, sewers.

Privatization of industry wherever it happens is usually an opportunity to profit. Government owned and operated companies are usually inefficient in marketing and production. They are run with agendas other than profit. Once a company is privatized, the management performance is judged on the basis of earnings and revenue. Decisions are made to eliminate the many obvious inefficiencies.

Opportunities for Further Research

Opportunities for further research include the following:

  1. Identifying additional indicators and indicators that more directly relate to the factors discussed in this paper. Data would need to be collected, analyzed, and scored.
  2. Determining the correlation between the indicators and the equity investment environment. The objective is to determine what are the meaningful indicators and to take the subjectivity out of the scoring. Additionally a better measure of the equity investment environment is needed.
  3. Analyze the investment environment in the context of the state of evolution for each nation. Michael Porter 17 discusses a model by which a country progresses through four stages of national competitive development: factor-driven, investment-driven, innovation-driven, and wealth-driven. It is likely that the attractiveness of the business environment will differ for differing types of business among the four stages. Some businesses will do well during a factor-driven stage; e.g. textiles, where others will due well during other stages; e.g. computers during the innovation-driven stage.
  4. Understand the dynamics surrounding currency devaluation. During the course of writing this paper, devaluation occurred in Czech Republic, Thailand, and Philippines currencies. Money making opportunities undoubtedly exist for those who understand how to predict when a devaluation will occur and what the result on equities will be. After the 1994 Mexico devaluation, equity prices were cut in half. Immediately after the recent Thailand devaluation, equity prices jumped.

17. Porter, pp. 683-685

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