Did IMF Pop the Emerging Markets Bubble?

Sometime in late 2007, a ‘new paradigm’ seemed to have emerged; that of fast-growing developing markets to trade at a premium to the developed world. I was in India in December 2007, and was often befuddled at some of the articles and conversations I came across. Indeed, brokerage houses pompously proclaimed the dawn of a new era in emerging markets. Investors, it seemed, would pay up for the faster growth, disregarding country risk, currency risk, inflation risk, home bias, etc. Truly, a ‘structural change’ seemed to have occurred.

Fast forward six months, and it’s a completely different cup of tea. A lot of ink has been spilled on the under performance in the emerging markets YTD. Some reasons discussed include:

• Increased risk aversion (flight to quality).
• Credit crunch induced liquidation of assets.
• Commodity inflation induced price shocks.
• Reversion to the mean in valuations.
• Reversion to the mean in profit margins.
• Decline in cost competitiveness due to commodity inflation, local currency appreciation and increasing labor costs.
• Debunking of the decoupling theory.
• Uncapitalistic regulatory and price control regimes.
• Political upheaval due to upcoming elections in India.
• *Insert favorite reason here*

Well, how about a new one?

In January 2008, IMF came out with a now forgotten report titled “Global Growth Estimates Trimmed After PPP Revisions”. The report trimmed the annual global growth estimates between 2002-2007 by 0.5% each year, definitely not a ‘rounding error’! More importantly, the contribution to the global output from China went down from 15.8% to 10.9%, and India's contribution was revised from 6.4% to 4.6%: a downward revision of almost 30%!!

Here's an interesting chart from the IMF report:

Quite interestingly, countries whose contributions held steady seem to have outperformed those who faced downward revisions.

If you look at the table above, India (INP) and China (FXI), two countries where the contribution percentages went down sharply, have underperformed in 2008. On the other hand, Japan (EWJ) and Brazil (EWZ), where contributions were (marginally) revised upwards, have held up rather well.

Is this merely a coincidence? While I don’t know the answer to the above question, it's certainly a good one to ask.

Parting thoughts: what are the possible implications of this 30% downward revision on the current commodity super cycle boom? A case maybe of going too far too fast?

Disclosure: None

Comments

[Stockguy456]

This is just growing pains until the global economy takes off which will be the biggest boom in history. The people who control the money know what they are doing. Once the energy problem is fixed it will be business as usual.

[johnthebear]

The fall of the emerging markets is not a surprise. The amount of the ultimate drop will be a big surprise to the markets.

Try this exercise in Yahoo. Enter all of the major market indexes and set the heading for the 200 day moving average. When you see markets all over the world trading at or below their 200 day moving average, one will be convinced that markets have not "decoupled" and things are going down hill fast due to the many factors listed above.

Now try this compare the ETF charts of each country with a chart that allows comparison with the NASDAQ in year 2000. Note the shape of the bubbles as compared with the NASDAQ on the rise, and on the fall. The market deflation on both the up and down sides are very much alike. This comparison gives an indication of how low each ETF might go as the hot air is released from each.

Also compare IYR, the Dow Jones Real Estate Index to these charts and you find a similar shape that lead to a bottom in 2003. All this suggest that the 3 year drop in tech stocks may be minor in size compared with what is coming. The basis of this conclusion is that the Dow & S&P did not get overvalued to the same extent, nor were the indexes around the world.

Most of the pain in 2000-2003 was limited to the tech area rather than a broad decline that affected markets all over the world. The same cannot be said this time. With Oil at record and rising prices along with other commodities surge in price inflation, the potential for a much sharper and longer duration downturn are a much greater risk.

This suggest a possible "recession" that might take twice as long to recover from since the emerging markets of the BRIC countries will not be available to help the USA AND THE USA WILL MARKET WILL NOT BE ABLE TO HELP THE BRIC COUNTRIES OUT OF "RECESSION"! Some may call this a global depression, worse than 1929. It would not surprise me. That is my bet. I own FXP and SRS to hedge against this risk. I am a bear on the market as you can tell from my name.

[Eric Fox]

stockbuyer....what do you mean by this:

"Once the energy problem is fixed it will be business as usual."

[User 86945]

Eric, I can't speak for Stockbuyer, but my best guess is that unfortunately he like many Americans have an inordinate amount of confidence in the ability of financial and political elites to "solve" problems for society rather than the sad fact that they can be depended on making them worse.

[deuxsous]

It looks like the PPP conclusions were released in December holidays and were not widely noticed, at least at my level. It's of enormous importance in puncturing the bubble myth of Chinese and Indian miracles. A 40% cut for China is huge.

Thanks for making this change better known.

[SIRIously Foolish]

Once upon a time we GAVE FREELY food, healthcare, and other support to the second- and third-world countries. SOME people complained that they should have to work for their keep. Well, now, they DO work for their keep, and are beating us at our own game, due to the enormous influx of poor people into the labor market. Many are very well-educated, at the expense of the state, and their high school graduates beat the pants off of our efforts to educate our self-centered, hedonistic youngsters who also have a full-blown sense of entitlement. When will we learn?