A Meltdown in Emerging Markets?

I found this article in the Telegraph warning of a possible meltdown in emerging markets caused by what looks like looming inflation problems.

The accompanying chart (above; click to enlarge) captures the Sensex in India and the Shanghai Composite for the last six months.

Looks to me like the crisis might already be here. There is no way to know at this point how big of an impact the points cited in the Telegraph article will have from here forward. Clearly declines like what you see on the chart are the attempt to price in something. A few months ago when the threat of inflation got less attention than it is getting now it seemed like there was not much concern about what was at the time a small dip.

Now that the dips have become more like meltdowns there is much more attention focused on the inflation issue. In this light it becomes reasonable to believe that the markets began to price in inflation problems last fall; may not be right but it is reasonable.

When things can't get any better, that means they cannot get better. We have been there a few times with emerging markets and also various segments of the materials and energy sectors and when things are going so well for something it might make sense to shave it down some.

This was the case with Statoil (STO) when I peeled off a little bit back in May. Not every sale can occur under this circumstance because not every holding will go parabolic, actually very few go parabolic. But this is something to be cognizant of for things that do go parabolic.

The other day I wrote a post saying that I think the time to buy China (in moderation) is very close and while my thoughts will either be right or wrong it is a safe bet that the Shanghai Composite, and anything else that is down a lot, will begin to discount the positives before the fundamentals show the positives.

We are at a point with these emerging markets where the fear about near term prospects (like the next couple of years) have escalated meaningfully. Adding a 2% weight in that circumstance is not the worst thing you can do and at 2% the consequence for being dead wrong is far from ruinous.

To be clear, I have not done anything yet with China, but if I do I will let you know. The point of this post is to point out some of the characteristics that are often present at big turning points.

Comments

[Obviously:]

This is a very cautious piece of writing.
And I don't know what this means:
When things cannot get better, that means they can't get any better.

2008 Jun 16 04:09 PM

[Alex_G:]

Roger,

Both China and India are very inefficient in converting energy use into GDP, the USA being 4x and Japan being 9x as efficient. Right now, their governments are subsidizing energy costs, to what degree is anyones guess. The net effect of this is transferring a portion of their foreign reserves to energy exporters.

High energy prices will affect these 2 economies (China more than India) far more than the US or Europe. As long as oil and coal prices stay at sustained levels, I believe both of these stock markets will face continued downward pressure.

I don't have the time to delve into the hard numbers and quantify the exact effects to their economies with any accuracy, so if anyone else has done the work, please share!!

Alex

2008 Jun 16 06:25 PM

[Roger Nusbaum:]

If it can;t get any better then that implies it will get worse.

Alex, no argument but it is part of the fundamental story and at least in part is priced in. There or course may be more pricing in to come.

2008 Jun 16 06:38 PM

[Alex_G:]

All you have to do is chart Brazil (net energy producer) Vs China to know that it is partially priced in. I also believe that China is hoarding oil (burning instead of coal near Beijing to cut down on pollution) ahead of the Olympic games and will reduce subsidies after the games.

The 50+ % drop in the Shanghai Composite is telling us something big.

2008 Jun 16 07:50 PM

[chennian:]

I'm fed up with people knowing nothing about China to make wild guesses about what is happening here. The decline in Shanghai market is related more to what happened 20 years ago when China started its stock market. In my personal view, oil price has a much bigger impact to U.S. economy than to Chinese one. High oil price will permanently reverse the lifestyle in the U.S. and consumer spending will be damaged. Urban living will prevail. Surburban housing will face more price pressure.

2008 Jun 16 11:37 PM

[Alex_G:]

Hey Chen,

Not a wild guess. 4x as much energy to produce a dollar of GDP. Fact. subsidizing energy costs. Fact. Manufacturing based economies are more energy intensive. Fact. Why is Brazil down 10% and Shanghai down over 50%?

I've been following the emerging markets for over 15 years and made a lot of money in these markets. The only ones I've been in since late September are latin america, eastern europe and a very small India position.

Watch what happens to energy subsidies in China after the Olympics. There might well be energy price protests.

Alex

2008 Jun 17 02:33 AM

[User 154465:]

Chen, sounds like you are very sensitive to any criticism regarding anything Chinese, one has to take the emotion out of investing and just look at the facts (as you see them) and make an investment call. Nothing to do with nationalism.

2008 Jun 17 08:19 AM

[johnthebear:]

Chip on shoulder is out of place Mr. Chen. Stick to the facts.

2008 Jun 17 09:19 AM

[johnthebear:]

As the world goes into recession, China will be hurt in a big way. Many banks have huge proportion of under performing real estate loans and property prices are highly inflated. Think about the speculation... China Oil is down 70% since last October.

After the games, I expect FXI to drop to less than $100, perhaps as low as $70. This estimate is based on a comparison of the decline of the NASDAQ in 2000 and the shape of the curve going up and down for both indexes. Plot both on a 10 year chart along with the other emerging markets and it becomes clearer the direction things are headed. Not knowable how far down anything can go.

Did you see that in the Lehman markdowns in their recent earnings report that they anticipate a 28% decline in property values in Europe? When values triple in 10 years, it makes sense and becomes comparable to CA in what might happen. How can China grow when their markets are shrinking?

2008 Jun 17 09:43 AM

[Zendurango:]

Another financial journalist saying something just to be saying something. The chatter is endless and needless -- and in this case confusing and obtuse.

2008 Jun 17 11:14 AM

[Oliver L.:]

Mr. Chen--perhaps you could say why you believe the recent downturn in the Chinese market is strongly related to how the Shanghai market was set up 20 years ago? If nothing else it would give less ammunition to those who are critiquing your tone.

2008 Jun 17 11:54 AM

[DonC:]

There's a disconnect here. The MS India Fund (IIF) just declared a 35% dividend (based on current fund share price of $24). Even if they declare no dividend in December - and they have paid a December dividend every year for nearly 20, that is a hell of a return even without price appreciation. Granted that that represents the past, not the future, and some economic slowdown has begun in India. But the fact remains that India is still growing very fast ahd stocks there are cheap.

I don't invest with commies so I don't do China at this time.

2008 Jun 26 11:03 AM