Decoupling Thesis Intact

The theory that economies in the rest of world, especially those in emerging markets, will “decouple” from the United States is taking some nasty hits lately in the financial press. The general comment goes something like this, “United States markets are down 10% this year, but emerging markets including China are down 20%. So much for decoupling.” Not only is this example unfair to the proponents of decoupling theory, it is incredibly shortsighted. It is right up there with “Hey, my neighbor’s house just sold so the housing crisis must be over.” It is simply wrong and irresponsible to imply that a couple of months of market gyrations should lead investors to ignore the possibility that international an emerging markets may prove to be better long term bets than the U.S. markets.

I guess the starting point of a discussion is to define “decoupling” as a global macroeconomic theory and not a stock market theory. As I understand it, decoupling proponents believe that the rest of the world will continually become less dependent on the United States and some day may even enjoy growth and prosperity while the United States stagnates or declines. Decoupling theorists partially base this theory on the idea that consumption in the rest of the world will eventually rise to a level where it can replace any consumption fall off from the U.S.. As this theory will prove out over the next decade and not over the next ten minutes, the implication for long-term investors is that they are well advised to continue to pursue opportunities internationally. I, for one, have separated short term trading themes from long term investments. Lately I have aggressively shorted the Chinese markets with the FXP etf but I maintain a strong international and emerging market component to my retirement accounts. Fear crosses international borders a lot faster than goods and services and stock markets can dive in unison worldwide, but I believe that long term economic prosperity is a lot less tied to stock market performance outside of the United States than the average investor might think.

Two of the most vocal proponents of decoupling that I have heard are Peter Schiff and Jim Rogers. Schiff, an investment advisor, is often paired against market bulls on CNBC and Fox and rarely gets to finish a sentence. He has, however, been dead right for years in encouraging clients to invest in foreign markets. It is his steadfast prediction of the decline of the American consumer that gets his microphone wire clipped. As long as I have read or listened to Schiff, he has flatly stated that decoupling is not an instant event and that initial declines in U.S. stock markets would be matched with market declines in other world markets. Schiff believes that foreigners will, however, eventually eschew the U.S. dollar and stop financing U.S. consumption. Instead, he believes foreign governments and investors will invest in their own domestic consumption and economies. If you understand that foreigners do indeed finance our consumption and debt, you know that his theory has merit.

Jim Rogers, a former partner of George Soros, is a legendary investor who is often credited with predicting the rise of the commodity markets in the last decade. He gets a lot more respect than Schiff, but his theory on the rise of the Asian markets and relative decline of America is very similar. He recently sold his New York home and moved to Singapore. In fact, Rogers is making sure that his young children (he has a younger wife I guess) learn Chinese, as he believes that China will eventually replace the United States as the world economic leader. Although Rogers believes in decoupling, he has been cautious on emerging market stocks and the last few times that I read or heard his commentary he was doing well shorting U.S. stocks while eagerly awaiting valuations in China to come in.

Certainly one must recognize that emerging markets are in much better shape to weather a U.S. downturn than in the past. China and India have changed dramatically in the past few years, their domestic consumption is rising at a robust level, and combined they have almost 10 times the population of the United States. While the U.S. government is borrowing billions against our children’s future to fund retail therapy for depressed homeowners, China is actually trying to slow its economy. Moreover, while capital constrained credit markets in the United States make news daily, hopes of rescue are pinned on sovereign wealth funds located in the same emerging markets that were previously dependent on the United States to finance their growth. No thoughtful observer of world markets over the last 10 years can help but notice that power has shifted. It would simply be arrogant to assume that it will not shift further, and that the day will not come when the United States finds that capitalism works so well that the rest of the world can survive without us.

Comments

[EL-GRECO:]

Inless you think sovereign wealth funds are dumb money, then you must agree that they are seeing either value or opportunity in the US.

2008 Feb 16 04:39 PM