Bubble Trouble for Emerging Markets

Beware financial advisors trying to lure investors into emerging markets. They make a convincing case. It is not hard when emerging markets have delivered such outstanding performance. But beware. You should always buy at the start of a bubble, not after it.

Unscrupulous investment advisers do not worry about such trifles. Their only concern is to get a fat commission on your investment.

China crisis

It is not as if the warning signs are not obvious. The boom in Chinese stocks has been breaking down since mid-August when astrologers had pointed to a coming crash, and there was indeed a major correction in China. Is that the start of a downtrend? Well, what has gone up usually comes down in stock markets.

But stepping back a little what is really worrying about the 62 per cent surge in emerging market stocks since the beginning of the year, a 94 per cent recovery from the lows of the crisis last year, is the extent of this upswing.

It is so strong and so quick that the only word to describe it is a bubble. In China, a stimulus package equal to half of GDP was injected into the economy in the first half of 2009 and this liquidity has been the main cause of the stock market rise.

Trade collapse

The fundamentals of a 20-25 per cent collapse in Chinese exports this year are clearly not the market driver. India has seen an even bigger collapse in trade. Russia is suffering from lower hydrocarbon prices. Winning the Olympics is likely a market top for Brazil.

Now liquidity driven stock market rallies are particularly prone to sudden and dramatic corrections without any warning. Basically somebody calls fire and everybody dashes for the exit. In the Middle East things look a little different.

For once the Gulf States are taking a more sober tack. Stock markets are way off their bubble peaks of 2006 and real estate prices have crashed over the past year.

But is this not actually a fairer reflection of the economic outlook and trade flows than the inflated financial markets of the BRIC countries? For the BRIC markets to keep going up they require the developed economies to recover back to their old boom levels, and this is just not likely to happen anytime soon.

No US recovery

Just look at the 263,000 extra jobless in the US for September, worse than forecast, or the 23 per cent fall in US car sales that month as the government’s ‘cash for clunkers’ program came to an end.

Clearly the fall in global trade is not going to be a passing phenomenon but a new economic reality for the emerging markets. In the Gulf States the financial and real estate markets are already beginning to reflect this vision of the future, but are probably still someway from bottoming out.

So would it not be foolish to invest in emerging markets at this point? The volatility of emerging market economies is notorious, and you should wait for the right moment which will only come when today’s investors have lost a great deal of money.

Comments

[Alan Young]

Mr. Cooper, please alert me when the next bubble is starting, so I can follow your advice and buy then.

2009 Oct 04 01:40 PM

[Ben Gee]

If China's economy still grow 7% when exports falls over 20%. Is there anything that can affect the Chinese economy? The world wide recession was the best thing China can hope for. It prevented China's over heating and now China can buy resourses at reasonable prices.

2009 Oct 05 12:47 AM