Emerging markets --- the linchpin of global recovery

Emerging markets represent incremental growth in the global economy. They soak up commodities. Their growing demand for consumer products to some extent offsets declines in demand from the U.S. and European economies and their lower cost exports continue to restrain inflation in the developed world. Just as investors in corporates focus intensely on the growth areas within a company, macro investors seek that growth on a global basis, country by country, region by region. In a period in which 3% GDP growth for the U.S., 2% for the U.K., 1% for Japan, and flat for Spain would be considered heroic, emerging markets are the fulcrum on which global growth sits.

It's true that emerging markets have been notoriously and painfully cyclical over many years. They have been hyper-vulnerable to shifts in global demand and to problems of their own making through currency policies, rigid protectionism, and unpredictable internal political and military turns that can lead to chaos. Now, with the emergence of China as an economic world power with previously unimaginable central bank reserves, with the market renaissance in Brazil, the unsteady but undeniable rise of India, and the relentless competitive striving of South Korea, emerging markets have been building a foundation that is demonstrably different from the past. Using the corporate analogy, the emerging markets also keep adding new products, or success stories. Look at Peru as an example. Ten years ago Peru was generally viewed as a dangerous backwater and an extremely high risk for investment. While Peru today still has somewhat of a wild west atmosphere, there is more stability and an economic growth story is underway that is reflected in a robust stock market. Whether it's Indonesia, El Salvador, Croatia, Vietnam, or many others, there is new incremental growth coming to the world economy from emerging markets. While these relatively small economies can face a volatile road ahead, their trajectory appears to be a zig zag upward.

Relative to the past this thesis may seem like the tail wagging the dog. Near term the solidity of the developed incumbents is essential and will continue to dominate the overall world economic picture. Longer term, the potential for exponential growth of multiple smaller emerging market economies combined with the maturation and significant market shares of the larger emerging powers is what will drive prosperity and the new growth that spurs the developed countries back from near stagnation.

Today some lead investors are looking for a 20% correction in emerging markets in 2010. Others see an early stage investment with some expected volatility which is heavily outweighed by the opportunity. Unlike even a decade ago, virtually all investors agree on one thing --- emerging markets, overweight, market weight, or underweight, are an essential part of any diversified portfolio. As one investor said on Bloomberg today, "You have to be there".