A Meltdown in Emerging Markets?

by: Roger Nusbaum

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 (NYSE: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.