Since 1998, the Morgan Stanley Capital International (MSCI) Emerging Markets Index has gained 13.5% per annum or 9.5% annually adjusted for inflation. That’s the highest total return posted by any broad global index over the last decade. This one number flat-out confirms that major markets have lagged behind emerging markets.

Indeed, emerging markets continue to post strong growth rates while the industrialized economies continue to struggle. Markets from the U.S. to the Eurozone are drowning under debt deflation tied to a financial crisis, rising long-term unemployment and declining standards of living.

The emergence of China as a major financial power combined with rich commodity-producing nations of Brazil, Russia and the Gulf States all point to a bright long-term outlook for emerging market plays.

It’s worth noting that emerging nations hit a bear-market low in late 1998 following the Asian economic crisis and the Russian ruble collapse.

At the time, this marked the best market-timing purchase among select global indices. We may see the same opportunity emerging here in the U.S. in the S&P 500.

For now, the S&P 500 Index remains hostage to a credit squeeze, deflation in housing, and a decline in domestic consumption. But that may all change soon.

Amid a 13-month credit crisis affecting most of the developed world, the United States might be at the cusp of outpacing other markets over the next decade. What happened in the emerging markets 10 years ago suggests this might be possible, at least from a contrarian investor’s standpoint.

PIMCO Scoops Fannie and Freddie Debt

Some of the best values now lie in distressed mortgage-backed securities like Fannie Mae and Freddie Mac bonds. PIMCO, the world’s largest bond fund manager with over US$800 billion in assets, has been aggressively accumulating the debt of both lenders.

Credit spreads for government mortgage agency debt have surged over the last few months and now trade at their highest levels in history compared to Treasury bonds. Premiums are now trading at just under 300 basis points or 3%.

The government has already guaranteed that both crisis-plagued mortgage lenders won’t fail. That means Fannie and Freddie debt is cheap at current prices, even though shareholders are likely to get wiped-out if the government eventually nationalizes Fannie and Freddie.

And as the mortgage market goes, so goes the real estate market…

Buying Up Busted Properties

U.S. real estate also offers excellent values, particularly from rising foreclosures and bank repossessions. This is exactly what occurred in the 1989-1991 Savings & Loan crisis. Then several years later, vulture investors earned big profits from buying cheap properties.

In the most devastated real estate markets of Nevada, Arizona, California and Florida, investors can find an abundance of residential and even a growing universe of commercial properties gone bust.

To be sure, financing has grown more difficult for even the most creditworthy of borrowers as banks balk at lending. But many deals will be closed in the coming months and years, as banks grow increasingly desperate to get rid of a truckload of properties at fire-sale prices.

Real estate in the United States is extremely cheap when priced in euro, yen or most other currencies. In 2007, more than 20% of all residential property purchased in Manhattan was by Europeans. I expect that trend to accelerate in 2008, especially if the euro continues to soften.

U.S. Stocks Offer Some of the Best Values in Global Markets –
Especially when Accounting for Currency Changes!

Lastly, U.S. stocks offer big values compared to other markets because of the potential for higher currency-adjusted returns.

Over the last seven years, dollar-based investors have earned big profits in overseas stock markets, using the dollar’s decline to rack up huge currency-adjusted gains in foreign stock prices. But the opposite might occur now similarly to the 1995-1999 period, when U.S. markets outperformed foreign markets.

Therefore, I expect U.S. stocks to finally benefit from a surge in foreign institutional money after years of net outflows. I also think the huge inflows into foreign equity funds will slow markedly over the next 12 months as mutual fund investors redirect capital to domestic funds, which have badly lagged behind other markets.