When it comes to global stock-market performance, strategists often speak of “decoupling,” which means the smaller but faster-growing economies in emerging markets have grown to the point that they are no longer beholden to investor sentiment about European or North American stocks. In effect, they’ve unhitched themselves from our wagon.

#-ad_banner-#Well, this notion turned out to be a myth. The up-and-comers can only rally when more established markets rise and they surely still fall when Western markets fall, as we saw in 2011. Most European stock markets fell by 10% to 15% last year, taking the rest of the world down with them. Adding insult, emerging markets actually fared worse than most European markets, because they are still seen as somewhat risky.

And while this was unfortunate for many emerging market investors in 2011, it’s looking like 2012 and beyond is setting up to be a good time for investors in certain emerging markets.

Take the BRICs (Brazil, Russia, India and China) as an example. These are emerging powerhouses, yet each of their stock markets fell at least 18% in 2011.

 
The weakest emerging markets were hit by a pair of factors. First, they have been wrestling with tangible growing pains as they transition from immature to mature economies. This kind of transition is often marked by inflationary pressures, infrastructure bottlenecks and the ever-present risk of a hard landing after a phase of extended strong growth.

Second, as I noted earlier, these markets are still beholden to fears of a spreading European contagion that can leave investors shunning risk. This risk circles back to the prior point, that emerging markets would suffer a hard landing in coming quarters if Europe slips into recession.

In reality, such a fear appears misplaced. Europe is likely to face a shallow or deep recession in 2012 — it’s too early to tell — but the emerging-market economies have such a head of steam that their greatest risk is slowing from scorching growth to simply “good” growth.

I’ll let the analysts at Scotia Capital summarize why I remain a long-term bull on the emerging markets group:

“The ongoing stronger economic performance in emerging nations will buoy global activity, and is causing a major shift in global consumption patterns. For example, car sales in emerging nations are expected to surpass purchases in the developed world in 2012, for the first time on record. These nations have also become the key drivers to global trade, with imports to developing nations expanding at double the pace of overall global trade. Demographic trends are reinforcing these developments, with these countries expected to account for virtually all of the increase in the global working age population over the next decade.”

You might have forgotten we’re in the midst of an impressive long-term boom in emerging markets if you simply looked at recent stock-price performance.

Let’s take Turkey as an example. Its market slumped 35% in 2011. In fact, the iShares MSCI Turkey ETF (NYSE: TUR) is now 10% lower than when it launched in April 2008. What’s happened since then? Turkey’s economy shrank 4% in 2009, but grew by a hefty 9% in 2010 and roughly 8% in the first three quarters of 2011 (fourth-quarter data are not yet released). Even assuming the global economy blunts that momentum and Turkey’s gross domestic product (GDP) growth rate slips below 5% in 2012, this is still an economy with abundant long-term potential.

Turkey has built an impressive array of trading partners, from the “Stans” bordering its Asian flank, the Balkan states and Russia to its north, oil-rich nations in the Middle East, and much of Europe, especially Germany. With the iShares Turkey ETF down from $70 last spring to a recent $45, Turkey’s market hasn’t been this appealing in quite a while — if you have a long-term time horizon.

I am similarly bullish on Brazilian stocks. Last August, I spelled out the country’s compelling set of strengths, and a month later, I named five stocks that could form the basis of a solid long-term Brazil portfolio.

Smaller, but still promising
Three other lagging emerging markets carry potentially solid upside but also carry their own challenges. The first one: Israel. Israeli stocks slid sharply last year even though the country continues to churn out a new crop of dynamic technology companies. Fears of a looming fight with Iran get some of the blame, as does Israel’s exposure to Europe, which is its largest export market.

It’s worth watching how events in Syria and Iran unfold, because if these two countries buckle under the weight of rising global sanctions, sponsorship of Hezbollah and Hamas would likely diminish. This could, in turn, set the stage for a less insecure Israel that is more comfortable seeking agreements with Palestinians. This obviously remains a long shot, but a potential “peace dividend” would be huge for Israeli companies, since they possess a lot of expertise from which neighboring countries would benefit.

Chile is another curious case. The country has been on a solid long-term growth trajectory, and rising economies in Brazil, Argentina and elsewhere are boosting Chile’s trade flows. But this economy is too beholden to copper, and as copper prices fell in 2011, so did Chilean stocks. The iShares MSCI Chile Index Fund (NYSE: ECH) began 2011 at $80, swooned to $50 last fall and can now be had for around $63. Copper prices are on the upswing, so this ETF could rebound nicely in 2012.

Lastly, I had a recent bullish take on India, but it increasingly looks as if I underestimated the country’s near-term challenges. The India Fund (NYSE: IFN) continued to slump for the rest of 2011, and despite a recent modest rebound, remains at levels seen back in 2004. India’s political and economic culture appeared to be shaking off decades of too much bureaucracy, but momentum appears to have stalled. Even with myriad problems, the Indian economy is expected expand at a 7% to 8% clip again in 2012.

This is surely a market worth monitoring, because an eventual pullback in inflation and broader infrastructure bottlenecks, or a change in the country’s political culture, could push this market right back into favor. This chart gives a clear glimpse of the stunning returns and horrifying dips this economy can produce.

 
Risks to Consider: It’s crucial to emphasize the phrase “long-term.” The near-term performance of these markets could suffer if the European mess deepens. The recent rebound in the U.S. market appears to imply that the worst has passed in terms of Europe-related risk, but I’m not so sure.

Action to Take –> There’s no need to quickly snap up shares of these emerging markets just because they sharply underperformed last year. Instead, the time is right to read up on these dynamic economies, focusing on those that appear best-positioned to generate steady long-term growth. Turkey and Brazil are my personal favorites, but some of the other countries mentioned in this piece may have even more upside if the global markets move up in tandem in 2012. 

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