Our generation has seen and heard its fair share of bunk economic theories. These are high-sounding theories that often are touted by recognized investors or higher learning institutions — and for that reason, they mostly remain unchallenged. At the top of the list is economic decoupling between emerging and developed countries.
How have emerging market countries fared this year? Is there any evidence they are decoupling from the rest of the world? And how can investors make informed and profitable investment decisions in this particular category? Read on:
Countries that are in the midst of rapid business growth and industrialization generally are referred to as “emerging markets.” With a combined population of almost 2.5 billion people, China and India are among the largest emerging-market countries.
The theory behind economic decoupling is that emerging-market countries can prosper and remain unaffected by adverse financial conditions elsewhere — particularly by the adverse financial conditions of developed countries such as the U.S. Decoupling has been heavily promoted during the past several years, especially by academic types in the mainstream press.
While decoupling might sound like a plausible idea, the performance for emerging-market stocks this year doesn’t support that view.
The Vanguard MSCI Emerging Markets ETF (NYSE:VWO) is down more than 19% year-to-date compared to lower-to-flat performance by the Schwab U.S. Broad Market ETF (NYSE:SCHB) and a 14% loss for developed stocks — Vanguard MSCI EAFE ETF (NYSE:VEA).
What about mega emerging-market countries like Brazil, Russia, India and China? As a group, BRIC country stocks — represented by the SPDR S&P BRIC 40 (ETF) (NYSE:BIK) — are down almost 19% since the beginning of the year.
The iShares S&P India Nifty 50 Index Fund (NASDAQ:INDY), Market Vector Russia ETF Trust (NYSE:RSX) and iShares MSCI Brazil Index (ETF) (NYSE:EWZ) are in bear market territory, down between 20% to 40% in value. Based upon the stock market’s performance, the theory of economic decoupling isn’t holding up, and neither is the argument of a soft landing.
The high-octane growth from emerging countries that analysts have been preaching is not as high or as fast as previously thought. China’s Consumer Price Index (CPI) and Producer Price Index (PPI) for November were a big disappointment. The year-over-year results were weaker than projected.
CPI was ahead just 4.2% compared to 5.5% in November 2010, and PPI for the same period was 2.7% compared to 5%. Also, declines in both China’s CPI and PPI were worse than what economists were projecting.
CPI measures the changes in the price of goods and services bought by consumers, while PPI measures the changes in the price of goods and services sold by producers.
In the manufacturing sector, China’s growth has slowed to its slowest level in two years, and home sales — along with exports — are ebbing. Premier Wen Jiabao’s formula to save China and the rest of the world by creating a lending boom is both odd and unimaginative. The strategy did not work in developed economies like the U.S. — and it won’t work elsewhere. (See the horrific results of former Federal Reserve Chairman Alan Greenspan’s decision to keep interest rates too low for too long.)
Financial Crisis Doesn’t Play Favorites
Europe’s financial crisis has taught us that a financial crisis doesn’t take a holiday, nor does it play favorites. The problems that began with fringe countries like Greece and Portugal have now infected France and Germany. How does this relate to emerging markets?
Emerging-market countries are not invincible like the enthusiastic academics paint them to be.
Interestingly, a Bloomberg poll of global investors showed that 61% expect a financial crash and a banking crisis in China by 2016. The poll’s respondents probably are right, with the exception that a Chinese blowup might not take as long to unfold as they assume.
Sixty-one percent of respondents said they anticipate a crash in the financial industry by late 2016, and only 10% were confident China’s banks will escape trouble, according to the quarterly poll of 1,097 investors, analysts and traders who are Bloomberg subscribers (conducted Dec. 5-6).
Nevertheless, there are a few holdouts.
Economists from Goldman Sachs (NYSE:GS) and the International Monetary Fund still forecast China will avoid recession and keep a lid on inflationary pressures. A report from Goldman Sachs in early December projected China’s GDP to grow 8.6% in 2012. To achieve results like that, China has zero margin for error.
Rather than buying into the popular theory of economic decoupling, we encourage investors to analyze the facts and remain skeptical.
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Ron DeLegge is the editor of ETFguide.com and author of “Gents with No Cents: A Closer Look at Wall Street, its Customers, Financial Regulators, and the Media“ (Half Full Publishing, 2011).