I recently attended a conference hosted by IPC called Emerging Markets: Opportunities and Obstacles. At the event, the Tabb Group presented some of their latest research on trading in the emerging markets of Eastern Europe and Asia. Then a panel of speakers discussed a range of topics related to trading in these markets. The conference also introduced IPC’s new financial extranet, Connexus. Here are some of the insights I took away from the fascinating panel discussion.
Emerging market GDP growth has outperformed growth in the developed markets every year since 2006 by an average of 9.6% each year. During that time the combined GDP of the emerging world has more than doubled while that of the developed world has only increased by 23%. Taken to scale, this doubling is amazing. The emerging and frontier world accounts for almost 85% of the world’s population with 2.5 billion people in China and India alone. At nearly six billion people, if only six per cent of these attain a higher standard of living and a higher amount of disposable income over the next decade, the markets will be faced with another 360 million consumers. More than the entire population of the United States putting pressure on resources, prices, and production.
The more things change, the more they stay the same
Clearly, asset growth and investment opportunities abound in the emerging world. Many investors point to this opportunity and the GDP outperformance in emerging markets as evidence of decoupling, that emerging market growth is no longer dependent on exports and growth in the developed markets.
While overall growth in the emerging space has consistently outpaced that in the developed markets, the iShares MSCI Emerging Markets Index (EEM) underperformed the S&P 500 by almost 20.5% in 2011 and is off its 52-week high by more than 25%. Global debt crises and uncertainty have kept correlations high since 2008 bringing down asset values in even the best performing economies. The correlation between the iShares MSCI EM Index and the S&P 500 were 0.84 over the last twelve months against a correlation of only 0.69 over the last six years. With asset correlations at these levels, relative economic growth means less than overall investor sentiment in the short-term.
The problem in the decoupling theme is that, while many emerging countries have shifted their export reliance from the U.S. and Europe, their economies are still largely based on an export model. The only difference is the name of the country on which they are dependent. Brazilian exports to the United States and Europe have shrunk from 41.1% of total exports in 2006 to a relatively smaller 32.1% in 2010, but exports to China more than doubled from 6.2% to 13.3% of the total. Exports to other developing Asian economies also increased from 9.1% to 12.6% of total exports.
And while many emerging countries are relying more on Asia for export revenues and economic growth, exports to the United States still account for 20% of Indian exports and 70% of Chinese exports are destined for developed markets. As Europe enters the third year of its escalating debt crisis and the U.S. is facing stagnant growth at best, the slowing economic environment will continue to show up in emerging market asset values.
Will the EM outperformance continue this year? Does it matter?
While investors and pundits alike are furiously bent on forecasting GDP growth and asset values for 2012, they run the risk of losing sight of the bigger picture. With the scale and long-term potential in the emerging markets, there is little doubt that the next 10 years will belong to BRICs, CIVETS, and the myriad of acronyms for the regions.
Short-term risks do exist. Much of the growth in the EM space is dependent on the voracious appetite of the BRICs for resources. The fate of the euro zone is more precarious than it has been ever in its 13 year history.
Rather than bet on some mystical decoupling, investors should invest for the long-term while hedging knowable short-term headline risk. The most obvious risk to global growth, and that which is keeping correlations high, is the risk that Europe cannot grow or restructure its way out of the debt crisis.
The alternatives to an orderly restructuring or growth are massive printing or outright default. Either option could be disastrous for the euro. Investors may look to shorting the euro in the futures market or through one of the available exchange traded funds to tactically position against short-term volatility. If the problems in the EU accelerate to the downside it will most likely take other asset values down with it, investors can use their short-term gains from shorting the euro to offset losses in the rest of their portfolio.