Dan Rasmussen, Verdad Advisers – Emerging Markets Crisis Investing (The Best Investment Writing Volume 6)

Episode Summary

Executive Summary: Dan Rasmussen argues that emerging market equities have repeatedly failed to reward investors despite higher GDP growth, because returns are driven more by liquidity, crisis frequency, and institutional stability than by economic expansion. He frames EM as a “crisis investing” arena where buying after panic and understanding recovery dynamics matters more than chasing growth narratives.

Main Topics: EM growth narratives versus equity returns (Priority: 5/5): The episode opens by challenging the long-standing belief that rapid GDP growth and global realignment should translate into strong emerging market stock returns. Historical underperformance of EM equities (Priority: 5/5): Rasmussen contrasts EM returns with the S&P 500 and notes that broad EM exposure has lagged developed markets for decades, including for investors who bought into the 2010s optimism. Value versus growth within EM (Priority: 4/5): He argues EM growth stocks were especially poor performers, while EM value stocks delivered returns closer to U.S. equities, suggesting style matters as much as geography. Crisis frequency and severity in emerging markets (Priority: 5/5): The piece emphasizes that emerging markets suffer more frequent and deeper crises, and that some countries never fully recover after major drawdowns. Liquidity and crisis investing framework (Priority: 5/5): Rasmussen presents Michael Pettis’s view that foreign liquidity from rich countries, not internal growth alone, drives EM booms and busts, creating opportunities for contrarian investors. Academic evidence on liquidity premiums (Priority: 4/5): He connects Pettis’s theory to financial literature showing illiquid assets, value stocks, and post-crisis EM trades can earn premiums, especially during global liquidity shocks. Gap between theory and practice (Priority: 3/5): The episode closes by saying the research is strong but practical, executable EM crisis-investing strategies are still underdeveloped on Wall Street.

Key Arguments: Higher GDP growth in EM countries has not reliably produced superior equity returns; developed markets, especially the U.S., have rewarded investors more. Investor enthusiasm for EM was built on a mistaken assumption that trade liberalization and globalization would mechanically boost stock performance. EM growth stocks have been a major source of underperformance, while EM value stocks were much closer to S&P 500-like outcomes. Emerging markets experience more frequent and more severe crises than developed markets, and recovery after large drawdowns is less reliable. Institutional fragility matters: political shocks, debt default risk, and weak central-bank credibility can trigger capital flight and prolonged damage. Pettis’s framework reverses conventional causality: liquidity from developed markets draws capital into EM and can create growth, but when liquidity disappears, crises follow. Liquidity premia and contrarian value opportunities are strongest in EM during global liquidity shocks, making crisis periods potentially investable if timed correctly.

Data Points: EM vs. S&P 500 profit from $100 invested in 2010: EM: $47 profit; S&P 500: $383 profit - Used to illustrate how poorly broad EM stocks have performed relative to U.S. equities since 2010. Average annual GDP growth: Emerging economies 4.7%; developed economies 1.8% - Shows that higher GDP growth in EM did not translate into stronger equity returns. EM growth stock performance since 1989: Worth less than half of the same investment in the S&P 500 or EM value stocks - Demonstrates that EM growth stocks were the weakest segment of the EM universe. Recovery after 50% drawdown: Developed markets recovered 92% of the time; emerging markets recovered 75% of the time - Supports the claim that EM crises are less likely to revert to prior highs. Philippines MSCI Index after 1997 crisis: Has never returned to its 1997 peak - Example of a market that did not fully recover after a major crisis. Time horizon referenced for crisis-recovery study: Since 1987 - The recovery probabilities are based on GFT equity data since 1987.

Pivotal Quotes: "It never happened." — Dan Rasmussen: A blunt rebuttal to the idea that capital flows and globalization naturally produced EM equity gains. "Growth doesn't attract investment, rather, investment causes growth." — Dan Rasmussen, summarizing Michael Pettis: Core theoretical claim explaining why liquidity conditions may matter more than local growth for EM performance. "What works on paper hasn't yet been put to work on Wall Street today." — Dan Rasmussen: Closing point about the disconnect between academic research and investable EM crisis strategies.

Implications: Listeners should be skeptical of EM growth stories and focus instead on liquidity, institutional resilience, and crisis timing. For investors, contrarian EM strategies may offer value, but only with careful attention to recovery risk and capital flows.