Financial markets are like a Rorschach test. The way investors and analysts interpret them tells you more about what's happening in their heads than in economies and boardrooms. When a market is depressed and widely avoided by the public, bears will point out all the things that are wrong with it and bulls will say it's cheap and unappreciated. When analysts at T. Rowe Price, an American fund management firm, gaze at the inkblot that comprises frontier stock markets, they adopt the second interpretation.
Economies and bourses considered insufficiently mature, large or open to qualify as emerging markets have underperformed by a wide margin for a year or more. As Price sees things, frontier markets are bargains that have been hard done by and are bound to catch up once investors recognise their virtues. That would be good news for investors in the UAE and other Middle East markets, which comprise more than 60 per cent of the MSCI Frontier Markets Index. The rest of the constituents are in Africa, Latin America, Asia and the fringes of Europe.
"Frontier regions have made large economic strides in recent years, as economies and capital markets have liberalised," Price says in a report. "The asset class remains undercapitalised and under-owned, with strong growth potential." Imagine if you could take the way-back machine to the early 1980s, just before emerging markets - the choice back then was limited to Korea, Hong Kong, Mexico and a few others - were on the launching pad, preparing for their wild ride to stratospheric returns? You would have hopped onboard for sure if you'd known what was to come.
The report's unnamed authors contend that frontier markets are roughly where those markets were then. "As the emerging market universe matures, investors are increasingly exploring opportunities in previously untapped markets outside the emerging mainstream," they say. "In many ways, frontier markets today are similar to mainstream emerging markets" before they became popular. Just using a term like "mainstream emerging markets" - something that would have been an oxymoron not long ago - shows how common they have become in the consciousnesses and portfolios of ordinary investors. These days it would hardly be remarkable to overhear grey-haired grannies discussing production targets for Petroleo Brasileiro over tea.
The markets that make the biggest moves are the ones with the greatest capacity to surprise investors. With China, Brazil, India and others the talk of the town in towns all over the world after the phenomenal progress that their economies have made, it's reasonable to think that the next big thing will be found in things that are small and barely noticed today. The Price report offers several reasons to think that frontier markets will be that next big thing. Their economies have a run of strong expansion ahead of them, the authors say, because they lag much of the rest of the world in certain key aspects of development and, more important, consumers, businesses and governments have the financial wherewithal, at a time when it's in short supply elsewhere, to do something about it.
"Corporate and personal debt levels have risen in recent years but remain low by global standards, [and] government balance sheets are generally in good order," they write. Strong economic growth "is additionally underpinned by a young population in most frontier countries at a time when the developed world is aging rapidly." The authors make a fair case for investing in the Middle East and other frontier markets. If you've already done so, then sit tight; their bullish comments may persuade others to follow suit and give your holdings a lift.
If you haven't plunked down your cash yet, there's no reason to rush into anything. All the points they make about frontier markets were true a year ago, before they underperformed, and two years ago, before they sank almost out of sight. Certain factors justify caution toward Middle East bourses, notably credit excesses in places like Dubai and Kuwait and the heavy weighting of financial companies in indices across the region. The heavy reliance on energy for economic growth is an additional source of volatility.
Investors in frontier markets worldwide should be concerned about lopsided capital flows in both directions, iffy standards of corporate governance and limited openness and transparency. And no matter how bright their futures are, it will be hard for frontier markets to withstand another global bear market, a development whose odds seem to have shortened in the last few weeks. So don't be in a hurry to buy. But once you do, as Price suggests, don't be in a hurry to sell.
"As with emerging markets before them, frontier markets are growing in stature," the report says. The markets "should be seen as a medium- to long-term trend that will eventually see the asset class become an integral part of any global equity allocation." Conrad de Aenlle writes from Los Angeles about investment and personal finance issues. His blog on contrarian investing for MoneyWatch.com, "Against the Grain", can be found at http://bit.ly/NjaBa