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taking stock

The Great Shift out of emerging markets gathered more steam last week, as a growing number of investors reached the inevitable conclusion that the risks now heavily outweigh the steadily diminishing returns. Libya's less-than-redoubtable dictator, Moammar Gadhafi, did his best to spark the exodus by exhibiting behaviour so brutally bizarre that it made ousted Egyptian president Hosni Mubarak seem a model statesman by comparison.

Investors yanked more money out of emerging-market funds for the fifth week in a row, according to EPFR Global, which tracks mutual fund flows. During that time, more than $20-billion (U.S.) has moved elsewhere, a lot of it to Europe, Japan and the energy sector. That tends to happen when oil prices reach triple digits - where they have remained since it became clear that OPEC member Libya was about to change ownership in a decidedly hostile takeover. Mr. Gadhafi was unable to take advantage of his insider's knowledge, because whatever loot he has stashed away in Swiss vaults has been frozen.

The disloyal opposition already controls key petroleum facilities in the eastern half of the country, which they have no interest in damaging. Indeed, they need the income even more than the Gadhafi family, which presumably had to pay cash upfront for the mercenaries who are keeping the mobs at bay in what's left of its rapidly diminishing fiefdom. But the foreign technicians who keep the oil pumps and pipelines working have all departed for safer places to wait out the storms. And they won't be back any time soon.

"Irrespective of whether Gadhafi steps down or not, the outcome in Libya is bad," says political risk expert Ian Bremmer, president of Eurasia Group. "We're very fortunate there aren't a lot of Libyas in the region."

Meanwhile, despite their natural instinct to seek safe harbours when they don't like the risk equation, investors cannot really afford to stay away from emerging markets for long. That, after all, is where the bulk of world growth is going to come from in the years ahead. And it will inevitably be accompanied by heightened political risk, said Mr. Bremmer, author of The End of the Free Market, about the rise of state-controlled (as opposed to free-market) capitalism in a large swath of the emerging world.

"I define emerging markets as countries where politics matters at least as much as economics or market outcomes. And it's not just oil or other resources," Mr. Bremmer said last week during a visit to Toronto, where he addressed a business audience at Grano restaurant as part of its salon speakers series. "You could make that argument for China, for India, for all sorts of countries. We're heading into a much more volatile environment driven by much more political risk."

That sure sounds like something I want no part of. But Mr. Bremmer disagrees.

"Emerging markets are clearly where you want to bet. But you have to be much more diversified and hedged than you are in the developed world, for reasons that, at least now, should be obvious."

That includes oil and other resources that Canadians know and love. "The kind of industrialization that we will see from emerging markets means that irrespective of how well or badly Libya fares, you're going to see a heavier push to the upside on basic commodities and input costs."

What about the argument that even such promising markets as Brazil have become overheated and overvalued?

"Brazil is certainly too expensive right now. And I think that it's due for a correction. But I'm not a short-term market-calling guy. I'm talking more structurally. I'm talking to people who are sort of the investment holds, [rather]than those who are dipping in and out of the markets tomorrow."

Those of us who are not market-dippers but still want to sleep at night can always stick to developed markets whose fortunes are linked to the Chinas, Indias and Indonesias - namely Australia and Canada. "If you want to bet on the developed markets now, you're betting on places that have the commodities play entrenched."

In his book, though, Mr. Bremmer warns that the inherently inefficient state capitalism adopted by so many emerging heavyweights is eventually doomed. China, he says flatly, "will not work as a state capitalist system long term, when they run out of cheap labour."

Why, then, should we be placing any bets on the much-hyped China growth story? "They're not running out of cheap labour any time soon."

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