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Germany’s Stunted Growth May Spread

The German government’s warning today that it’s likely to have slower growth in 2012 was another blow to the struggling continent. But advisers say the ripple effects may also hurt another favorite of American investors: Emerging markets.

After growing 3% in 2011, German GDP is now projected to increase just 0.7% this year. Not only does that make a recession in Europe more likely, but it may lead to an even bigger slowdown for popular emerging markets, which have already been floundering. In 2011, the average emerging market stock fund fell about 19.9%, according to data provided by Morningstar, while the average large blend fund was down a comparatively reasonable 1.3%.

And yet, investors have continued to flock to these markets, drawn by the promise of faster growth. Emerging market stock funds scooped up more than $17 billion in 2011, gathering positive inflows every month except December, according to data provided by Lipper. Meanwhile, domestic stock funds have suffered more than $95 billion in outflows, more than double the $26 billion in outflows the category saw last year, according to Lipper data. “Investors have been on strike against domestic equity funds,” says Jeff Tjornehoj, a senior analyst for Lipper. So far in January, domestic stock funds are still bleeding money, while emerging market stock funds are again enjoying inflows.

While fund flows typically chase performance, there’s often a lag between when the performance falters and when the investors start heading for the exits, McDevitt says. Emerging market investors are probably still basking in the glow of a winning decade, in which the average fund in the category gained 12.8% annualized, compared to the average large blend fund’s 2.6% annual gain. Even in the past three years, emerging market funds still come out ahead, up an annualized 18.3% compared to 13.2% for the average large blend fund. “Emerging markets just had an exceptional decade,” McDevitt says.

With the U.S. consumer still fairly slow to spend and Europe headed for recession, this isn’t a good moment to be buying up emerging market stocks, says Matt Bellew, the chairman of Security Ballew Wealth Management. “What’s happening here and in Europe should have a pretty big impact on emerging economies,” Bellew says. If developed market stocks struggle in 2012, emerging market stocks will suffer worse, just as they fell harder than developed market stocks in 2008, he says. Emerging markets “will be the place to be eventually,” Ballew says, but “they have got a lot of downside potential — a lot — for a while.”

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    • I agree. If the euro collapses, EMs will tank, and that’s just too much risk for my taste. US equities will take a hit, too, but nothing like the rest of the world.

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