An Outcry from Emerging and Developed Markets Alike

by: Jonathan O'Shaughnessy October 16, 2008 | about stocks: EEM / FXI / INP    

Jonathan O'Shaughnessy

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Last week's economic fallout has left many people shell-shocked and asking the question "How could this happen?" Every economy in the world has been affected and I personally believe we won't fully realize the ramifications of it for multiple months at the earliest. The worst part is that the vast majority of the people who will be the most affected are those that don't even understand what's been happening in the financial sector.

In an AP article released in the Seattle Times yesterday morning entitled: "Emerging Markets Suffer as Foreigners Withdraw," the author discusses how many of the frontier and emerging market economies will be hit the hardest as investors pull out their money. In the middle of one of the worst economic periods of stability in history, investors are running for the hills (or wherever they perceive there is sure-footing). According to the Emerginvest heat map, China's Shanghai A Shares index is down 66.5% for the year (FXI), India is down 43.4% (INP), Russia is down 63.5%, and the iShares MSCI Emerging Markets Index (EEM) is down 54.4% since its high last year (to name a few).

Here's the Emerginvest Outlook Graphically: (Click to Enlarge)

Investors immediately write off emerging markets as their "risky" assets, so those are typically some of the first to be sold. The Seattle Times article states that "private sector capital flows to 30 emerging market nations across the world will fall by nearly a third from last year."

While there are tremendous up and down swings in emerging markets, every economy in the world is being rocked by the financial waves. It's just the environment. Yet, according to the Times article:

The exodus has prompted a chorus of protest in the emerging world: We did not cause this global meltdown, our economies are still growing, our banks don't have much exposure to the toxic securities at the core of this crisis.

Why must we suffer, they ask.

'It doesn't seem fair to me that those of us who endured so much hunger in the 20th century, who began to improve in the 21st century, should have to suffer due to the international financial system,' Brazilian President Luiz Inacio Lula da Silva said recently.

India's Finance Minister P. Chidambaram this week reiterated that India's economic fundamentals are healthy. 'We must banish fear,' he said.

Without arguing about who is to blame for the banking crisis, the truth is that an extremely significant portion of foreign investment is being sucked out of these countries' economies – many of whom have been relying on it to fuel growth. For the most part, their fundamentals are strong, and yet they are feeling the windfall just as much as those countries with large amounts of toxic debt like the US.

While I don't 100% agree with the spin that they are merely victims in this mess, they are more vulnerable than most of the developed markets and I can personally see where their public outcry originates from. Their protest is that they didn't do anything wrong in the financial mess. However, even if that was 100% true, their plight is based on foreign investors' perceptions of risk. That isn't necessarily a fault of the global economic system, but more a "consumer mindset" to steal a marketing term.

I honestly don't know yet if the recent economic shift will make investors think of emerging markets as more or less stable. I would like to think it would shift the common investor's perspective to relatively "more stable" because of the developed markets' recent volatility recently, but we will have to wait and see.

However, emerging and frontier markets aren't the only ones crying out for a change to the financial system. Four hours ago, British Prime Minister Gordon Brown called for a global economic summit. According to an AP article: "Britain Calls for Global Finance Summit," Brown said: "I believe there is scope for agreement in the next few days that we will have an international meeting to take common action ... for very large and very radical changes…. The IMF has got to be rebuilt as fit for purpose for the modern world. We need an early warning system for the world economy."

Building on my last comment, I think that everyone – from governments to common investors, have realized that the world economies are much more closely linked together than they had previously thought, and are subsequently much more vulnerable to global movements. I think that most had viewed developed markets as fortresses of security, and after the record lows of last week, investors had a rude awakening. At this point, I do believe a global summit will take place after the unprecedented unified response from world financial leaders, however I don't know what kind of result we should expect to see from such a meeting.

Regardless of the result, I think that it is the best response to the emerging markets' outcry as they will see. They cannot change investors' perspectives of risk overnight, but a successful outcome of such a summit would raise their standing in the world financial community.

It will certainly be an interesting few months.

Stock position: None.

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This article has 7 comments:

  •  
    Oct 16 08:34 AM
    those emerging markets emerged,becuase they rode our coat tails on the way up.if they were so strong they wouldn't be down so much now.
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  •  
    Oct 16 10:38 AM
    If the economies of those emerging markets are growing without the need for credit then they will continue to prosper and their markets will eventually draw capital.

    However if they have patterened their economies on the US model where 'growth' is only achieved via ever-expanding credit they too will flounder as foreign money returns home.

    Bubble-nomics isn't self sustaining in the long run.
    Reply | Link to Comment
  •  
    Oct 16 11:24 AM
    Black and Smarty,

    I don't disagree that they were taking in disproportionate amounts of foreign credit to sustain their growth - and I fully agree Smarty, "Bubble-nomics isn't self sustaining in the long run."

    That being said, they were doing relatively well with the capital they had borrowed. China and India were the darlings of the economic world as they expanded. I agree that they perhaps did so a bit too fast.

    I guess my point with this article was that both emerging and developed are calling for change for two very different reasons. I dont know if anything can be done about investors pulling money out of emerging markets, but I do think the developed markets will have a unified response. I guess we'll see.
    Reply | Link to Comment
  •  
    Oct 16 12:31 PM
    Jonathan:

    I think what's happening with emerging markets is an excellent example of manic-depressive Mr. Market. Market price movements have had little to do with underlying reality and as a result a large gap (read buying opportunity) has opened up.

    Most emerging markets are in excellent shape - including massive trade surpluses and foreign reserves which will enable them to ride out the current crisis in relative comfort - and even come bottom-fishing in the US before too long. Only a relative few are dependent on foreign investors (Baltics, Balkans, Hungary, Turkey, maybe South Africa, kinda sorta maybe India).

    Right now you can buy the Chinese market for a P/E ratio of less than 10, or the Russian market for a P/E ratio of less than 3! These prices are very low and won't last long.

    I'm sure there are other bargains out there after all the panic selling, but emerging markets are really a phenomenally good bargain right now. It's a great time to take advantage of other people's misconceptions and panic.
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  •  
    Oct 16 01:15 PM
    What happens in the catch-up affect when the original players being caught up to take a dive?
    Reply | Link to Comment
  •  
    Oct 16 02:40 PM
    My view:

    1) Hedge funds put a lot of money in emerging markets because of their growth potential. The funds are now withdrawing investments, taking profits where they can get them, to pay for mounting redemptions. Every market tick down now equals 10 ticks up on the margin call meter, and all that leverage has to get paid down quickly.

    2) My biggest fear is that, if the coordinated response to the global crisis actually works, it will "justify" consolidation of the global financial system under one central body. That body won't be the World Bank (nobody trusts them), but it could be a global oligarchy of the few "too big to fail" banks left standing - a global shaddow government controlling worldwide commercial activity through its control of credit.

    And, it'll be basically the same guys running the new global financial system as screwed up the current "national" ones. A global meltdown of the existing systems sure seems convenient, if the plan is to build a new consolidated global system for fun and profit. At least, it should give all the "new world order" conspiracy theorists something to chew on.
    Reply | Link to Comment
  •  
    Oct 16 04:45 PM
    Jonathan

    You look very young. What are your qualifications?

    While your article sums matters up very well, it is short on constructive suggestions

    Do you have any ... other than a global talk fest ?

    What co-ordinated decisions would you recommend?

    With Best Wishes and Genuine Interest in Your Views

    Friar Hilarius





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