Vitally important for being a successful investor is the ability to look beyond ‘buzzwords’, acknowledge that a wobble can be more dangerous when the training wheels come off and understand the nature of those that hold the future of the company / country / financial market in their hands.
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1. Catchy titles do not tell the full story
Differences will lead to varying economic and financial market success: There are numerous ways to group countries, none of which are fully satisfactory. From current accounts to interest rates, countries classed as ‘emerging’ are vastly different from one another. For example, Turkey is heavily reliant on foreign funds and therefore more vulnerable when foreign investors pull their money out, whereas China has a stronger account balance and therefore more protected. Lesson: Watch the balance sheet.
2. Leaders govern differently
Investors don’t like uncertainty: Political instability has been another cause of recent turmoil in Emerging Markets. Ukraine’s Prime Minister resigned after a 2 month stand-off with anti-government protesters and a stock market that had fallen 70% over 3 years. Lesson: Watch management.
3. There are two sides to every coin
Supportive policy action can only take investments so far before negative news flow becomes too hard to shrug off. While raising interest rates may dampen falls in a country’s currency in the short term, this is not always enough to calm a sell-off and a higher interest rate can hamper growth, squeezing the country further. Despite an interest rate hike, the Turkish Lira resumed its slide as sentiment soured. Lesson: Watch borrowing costs.
4. The customer is always right
‘Understanding the customer’ is paramount to understanding the value of a business. The geographical location of corporate customers varies. While ‘Emerging Markets’ contribute about 40% of global growth, their contribution to S&P 500 earnings is lower. Even within the US, certain sectors have varying protection from turmoil. Lesson: Watch the source of corporate earnings.
5. Shareholder intentions can determine stability
The characteristics of the largest shareholders in a business can impact its future. Stock markets can be dominated by domestic or foreign investors, long-term or short-term, investing for their pensions or trading in a hedge fund. Their comfort, knowledge and familiarity with the market, as well as how long they intend to hold investments, can shape how vulnerable a market is to sharp sell-offs. Lesson: Watch the shareholders.