Decoupling? But We're All in This Together

Includes: EEM, EEV, FXP, GMM, PXH, VWO
by: Andy Abraham

Many in the financial world believe that the emerging markets, and to a lesser degree Europe, will be able to maintain the momentum to keep the global economy on track. The question is “Will there be decoupling of world economies this time, or will the contagion spread throughout the world's economies”?

The background and the current realities make the latter seem more plausible. The gyrations in the world's markets have been nothing less than stomach-turning. The U.S. stock markets have fallen more than 200 points and then risen 200 points. We have witnessed both U.S. banks and international banks writing off billions of mortgage losses. There is a growing reluctance to lend, and tightening standards both domestically as well as internationally. Norinchukin Bank in Japan, a fishing and agricultural cooperative, just announced a $358 million write off due to mortgage losses. How can banks all over the world from Europe to Asia write off bad loans, and this not affect both their balance sheets and their propensity to lend? Historically, when there existed careless cheap money, the effects of liquidity were profound. Why should this not happen this time?

Are we in the throes of a Global Credit Crunch!

It is rather disturbing at best that Citigroup (NYSE:C) after years of providing liquidity and loans to individuals as well as businesses throughout the world, needed an external source of capital (Abu Dhabi government $7.5 billion). Cititgroup is paying an 11% annual yield until [if] equity units are converted into stock. It is very probable that Citigroup is not alone on Wall Street seeking additional sources of capital, and that greater losses than detailed are prevalent on the street.

Another example in our thesis of a potential global slowdown (at best) is what has been lately transpiring in the Baltic Exchange Dry Index and Global Shipping rates. The Baltic Dry Index is an index covering dry bulk shipping rates of such commodities as coal, iron ore and grains. The index provides an assessment of the price of moving the major raw materials by sea. They have fallen by approx 10% in the last 2 weeks (less demand and lower prices).

The issues of the world’s economies are very highly correlated. For example if China does not accept the U.S. dollar and the debt, she could experience massive capacity. China needs to keep exporting in order to keep its economic engine running. If China reduces its exports, this action could easily lead to China’s own recession or worse. The Chinese stock market, as well as real estate market, could be greatly impacted. Due to Chinese massive and cheap exports, the U.S. got addicted to cheap Chinese credit, and China got used to tremendous U.S. Treasuries. This symbiotic relationship built over many years is hard to break.

Many other emerging markets live by exporting. The caveat is that they are sensitive to global credit, and, as discussed earlier, the banking sector has been pulling back not just from the mortgage debacle but from the merger & acquisitions that were prevalent over the last years. Please tell me how the economic contagion has not spread or will spread? To me it is very clear how inter-related all of our economies are.