Two Worlds – One Market?
March 8th, 2011
We are living through a phase in markets when investors say they like western shares and dislike emerging market shares. This follows a couple of years of recovery when emerging market economies have grown far faster than developed countries, and when most emerging markets have risen more quickly than developed markets.
The rationale is simple. Investors rightly point out that emerging market economies now face substantial inflation, and will rein in money growth to try to stop prices rising so rapidly. Meanwhile, led by the USA, the west tries to retain a loose money policy as it is still primarily concerned that the recovery will falter. The newly printed dollars find their way into share markets, and it seems into commodity futures markets as well. The more they drive the price of commodities higher, the more the emerging market governments have to cool their economies. Commodity prices, especially food, play a bigger part in emerging market family budgets than in the west.
The view that the west is currently best has taken heart from the outbreak of strong protest movements throughout the Middle East. It gives the share bears another part to their story. Why not cut your risks in emerging markets. There could be a revolution in the country of your choice, or there could be disruption to oil supplies which will drive oil prices higher and help to stall the emerging market growth story. None of us wish to see more violence, though we would like to see democratic regimes in place that were more responsive to their voters needs. There is still much to worry about.
So far these pundits have been right. Indian and other emerging market shares have fallen as hot western money has been pulled out. Wall Street has led a revival of fortune in western equity markets. This trend could go on for a bit longer. The Middle East crisis remains unresolved.
However, we need to remember that the world economy is now more globalised and integrated. Were the emerging market governments to overdo their slowdown and stall their economies, it would not be good news for the west either. Emerging market economies have been accounting for more than half the growth of the world economy recently, with their newly enlarged contribution to world output. Western countries depend on exports to them for more of their income. Many western companies have committed large sums to investment where the growth is. These investments would be damaged by a stop to emerging market growth.
So too would resource shares be damaged. Commodity prices have been buoyed by emerging market demand. Any large downturn would squeeze inflation right out of the system, bringing down commodity prices and with it undermining the profits of all the many western businesses that have been riding the commodity boom. The UK, Canadian and Australian stock markets have substantial resource sectors that would feel the draft. The banks too would be uncomfortable with a major slowdown in the fastest growing parts of the world, with obvious consequences for business and property loans.
The west should hope that China, India and the rest judge controlling inflation well. It is in all our interests. If the emerging markets get it wrong, western equities will end up suffering as well. If they get it right, emerging market shares will start to perform well again. Though they don’t sometimes acknowledge it, all bullish investors are assuming the emerging markets will slow but not suffer too badly, and assuming the Middle East will stabilise without a big surge in oil prices. We are all in this together.
As Published in Investment Week
