Update HDFC Bank (HDB)

At the end of January the Reserve Bank of India, the country’s central bank, held a conference call for analysts and investors.

The message: The bank is worried about continued growth in government borrowing and strong demand for loans from the commercial sector. And that the bank will move to reduce excess liquidity in the banking sector before it leads to rising expectations for higher inflation.

Look out Indian banks, higher interest rates ahead.

I’d be surprised if Indian bank stocks didn’t retreat as the Reserve Bank of India moves from rhetoric to action.

Shares of Indian banks such as Jubak Picks 50 member HDFC Bank (HDB) are already down 20% since January 19 as part of the global correction in emerging markets. Any further decline would give long-term investors who are impressed, as I am, by the results out of Indian retail banks a chance to get into (or add to positions in) the sector at a reasonable price.  (For more on building a global portfolio see my post http://jubakpicks.com/2010/02/05/how-to-build-a-global-portfolio-what-countries-do-you-want-to-own/ )

How to buy into emerging market stocks now

Here’s the dilemma.

Long-term emerging market stocks are going to beat stocks from the world’s developed economies like a drum.

Everything right now points in that direction.

• Growth rates: For example, the United States looks likely to grow by 2% to 3% annually over the next decade (if it’s lucky) and China, India, and Brazil are projected to grow at twice to four times that speed.
• Debts: Developed economies such as Japan, the United States, and the United Kingdom will spend the next decade trying to dig their way out from under a mountain of growth-crippling debt while China and the rest of the world’s developing economies have emerged from the global financial crisis with comparatively undamaged balance sheets.
• Demographics: The developed world has to find a way to finance the “golden years” of rapidly aging populations. For the next decade, at least (and longer in the case of India), the economies of the developing world will be decisively younger. And growth, the historical pattern shows, goes to the young.

But in the short-term emerging stock markets look risky.

• Everybody suddenly loves them. And every guru is saying, You’ve got to be in emerging market stocks.
• Emerging market stocks are expensive. The companies in the MSCI Emerging Markets now trade at 24 times earnings. The last time the price to earnings ratio on this index was this high was in April 2000. Remember April 2000? Not the greatest of times to enter any market.
• The Chinese government and central bank keep signaling that they’re going to start slowing bank lending—and every time they do the market jumps like a cat landing on a hot tin roof.
• In the short-term emerging stock markets will take a licking if the developed world slides into another financial crisis. And that seems like a very real possibility somewhere in the belt that stretches from Athens west to Tokyo.

So is there a solution to this dilemma? A strategy that promises a way to navigate the short-term potholes while keeping your portfolio vehicle intact until the long-term arrives?

Sure. There are plenty of them. Let me lay out your choices and suggest those that make the most sense to me.

How to escape the next lost decade

A lost decade.

1999 to 2009 sure qualifies for many investors in stocks.

A lost decade to come?

I can’t tell you what stocks or stock markets will perform best over the next ten years. But I can tell you that many U.S. investors are still sitting in portfolios that increase the odds that the next ten years will be as unrewarding as the last ten.

Dollar up and stocks down–don’t expect that to continue

I can’t tell you where stocks are headed in the short term but it does look like the days of the dollar rally are numbered.

Why do I think that? The central bank of India tells me so.

And if the recent relationship between the U.S. dollar and global equities holds, that means stocks are set to end their current losing streak in the not so distant future. (Recently stocks have gone up when the dollar ha gone down.)

The U.S. dollar has an interest rate problem–and it looks like it’s getting worse.

To find the next McDonald’s look to emerging markets

By 2015 one-third of companies in the Financial Times Global 500, a list that’s roughly the global equivalent of the U.S. Standard & Poor’s 500 stock index, will come from the world’s emerging markets, according to Bain & Co.

Makes sense to me. Economic growth in general is higher in the world’s developing economies, such as China, India, Brazil, and Indonesia, than in the developed economies of the United States, the euro zone, and Japan.

The growth differential is even greater when you look at just that part of the global economy that McKinsey & Co. called fast-moving consumer goods, exactly the segment of the economy that spawns the brand names that give a company the kind of broad-based popular recognition that translates into a big stock market capitalization. Compound annual growth in fast moving consumer goods in developed markets 2005-2010, according to McKinsey, will average 4% for developed economies. Germany at 3% will be slightly below average. The United States and the United Kingdom will be slightly above average at 5%.

Compound annual for fast-moving consumer goods in developing economies is forecast to be more than twice the developed world figure at 10%, according to McKinsey. China and India are forecast to show growth slightly above the developing economy average at 11% each. Indonesia is forecast at 16%.

And there’s more trending in the direction of increased representation for emerging markets among the list of the world’s biggest companies than just that big growth differential. As if that weren’t enough.

Global cash flows are moving in the same direction. Global financial assets had climbed to $167 trillion by 2006, up from $43 trillion in 1990, according to McKinsey. Emerging markets accounted for $24 trillion of 2006 total. That’s more than half the global total in 1990. Among emerging markets in 2006, China accounted for $8 trillion, “other” Asia for $11 trillion, and Eastern Europe for $3 trillion.

The flow of global financial assets toward emerging markets has still left them under-represented in the financial markets. In 2006 emerging markets accounted for 23% of global GDP but just 14% of global financial assets.

By this point your question should be, How do I get in on this trend?