Emerging markets have been riding high for the past few years and the returns from some of them have been nothing short of astronomical.Â
By way of example Peru 's Lima General Index has posted an annual gain of 87.5% in the past 5 years while for Brazil 's Bovespa index it is 74%. The same thing goes for performance figures over the short term, with the Shanghai Composite index posting a jaw dropping return of 180% over the past 12 months.
However I believe that these hot markets are about to turn very cold and that the trigger for their hard landing has already been pulled. In this regard, one common thread that runs through most of the countries producing these strong gains, is that they are commodity exporters and have been riding the commodities boom since the beginning of the century. The key exception is China, which instead of exporting commodities has been sucking them up like a gigantic vacuum in order to fuel the massive development in its infrastructure and industrial base and also churn out cheap finished goods for the world markets. This means that even the Chinese economy with its huge trade surplus is no different from other commodities dependent emerging countries in that it is also exported oriented. What this means is that if there is a marked slowdown in the economic growth of the countries that buy its manufactured goods, China will also face a slowdown which will then roll down the line to the above mentioned commodity exporting nations.
In my view there is no doubt that the recent alarming developments in the market for subprime loans and asset backed paper including CDOs, which have sparked off a credit crunch, will slowly but surely lead to a deep recession in the United States. In turn, this together with the increasingly weak dollar will lead to a reduction in the demand for Chinese manufactured exports by US consumers and the same trickle down effect will then spread to countries such as Brazil and Peru, which respectively export huge quantities of iron ore and copper to China. By the same token, their commodity exports will become more expensive on the world markets due to the weak dollar.
However, a more immediate consequence of the credit crunch is an aversion to risk and a flight to safety. This will inexorably lead to a widening of credit spreads between emerging market bonds and 10 year Treasuries which until recently were at all time lows. In the same way that a widening of spreads of junk bonds and subprime loans has led to the sudden gut wrenching volatility in the US and European financial markets, I believe that the same scenario is about to unfold on emerging market stock exchanges. In fact a similar event took place in late 1997 following the Thai currency crisis when emerging markets from Latin America to the Far East suddenly convulsed and went down in a frightening spiral with some markets suffering huge losses within a few months. Just like today, most emerging markets at the time were doing exceptionally well and I remember that the Russian stock market in particular was on a tear and had gone up about 180% in the previous year before being brought down by the crisis.
Another major problem with these markets is that they are currently priced for perfection with blue sky valuations which do not reflect the underlying fundamentals of their economies. This can be seen in the case of Peru , where the Lima General Index has gone up almost 18 times over the past 5 years. However Peru 's GDP has definitely not gone up by the same amount, and neither have the earnings of its copper producers. It is therefore clear that these markets, which are not as liquid and well capitalised as the US and European markets, have really gone up on the hopes and expectations of millions of investors that their outperformance will continue. I believe that once these expectations take a knock, as they soon will, the results will again remind another class of 'investors' about the age old adage: All that glitters is not gold.
Happy investing
Anthony Ogunfeibo is the founder and Editor of www.alternativeanalyst.com a value investing website. His goal is to set up an investment fund which will acquire cheap assets and allocate capital to undervalued companies with durable competitive advantages.
By way of example Peru 's Lima General Index has posted an annual gain of 87.5% in the past 5 years while for Brazil 's Bovespa index it is 74%. The same thing goes for performance figures over the short term, with the Shanghai Composite index posting a jaw dropping return of 180% over the past 12 months.
However I believe that these hot markets are about to turn very cold and that the trigger for their hard landing has already been pulled. In this regard, one common thread that runs through most of the countries producing these strong gains, is that they are commodity exporters and have been riding the commodities boom since the beginning of the century. The key exception is China, which instead of exporting commodities has been sucking them up like a gigantic vacuum in order to fuel the massive development in its infrastructure and industrial base and also churn out cheap finished goods for the world markets. This means that even the Chinese economy with its huge trade surplus is no different from other commodities dependent emerging countries in that it is also exported oriented. What this means is that if there is a marked slowdown in the economic growth of the countries that buy its manufactured goods, China will also face a slowdown which will then roll down the line to the above mentioned commodity exporting nations.
In my view there is no doubt that the recent alarming developments in the market for subprime loans and asset backed paper including CDOs, which have sparked off a credit crunch, will slowly but surely lead to a deep recession in the United States. In turn, this together with the increasingly weak dollar will lead to a reduction in the demand for Chinese manufactured exports by US consumers and the same trickle down effect will then spread to countries such as Brazil and Peru, which respectively export huge quantities of iron ore and copper to China. By the same token, their commodity exports will become more expensive on the world markets due to the weak dollar.
However, a more immediate consequence of the credit crunch is an aversion to risk and a flight to safety. This will inexorably lead to a widening of credit spreads between emerging market bonds and 10 year Treasuries which until recently were at all time lows. In the same way that a widening of spreads of junk bonds and subprime loans has led to the sudden gut wrenching volatility in the US and European financial markets, I believe that the same scenario is about to unfold on emerging market stock exchanges. In fact a similar event took place in late 1997 following the Thai currency crisis when emerging markets from Latin America to the Far East suddenly convulsed and went down in a frightening spiral with some markets suffering huge losses within a few months. Just like today, most emerging markets at the time were doing exceptionally well and I remember that the Russian stock market in particular was on a tear and had gone up about 180% in the previous year before being brought down by the crisis.
Another major problem with these markets is that they are currently priced for perfection with blue sky valuations which do not reflect the underlying fundamentals of their economies. This can be seen in the case of Peru , where the Lima General Index has gone up almost 18 times over the past 5 years. However Peru 's GDP has definitely not gone up by the same amount, and neither have the earnings of its copper producers. It is therefore clear that these markets, which are not as liquid and well capitalised as the US and European markets, have really gone up on the hopes and expectations of millions of investors that their outperformance will continue. I believe that once these expectations take a knock, as they soon will, the results will again remind another class of 'investors' about the age old adage: All that glitters is not gold.
Happy investing
Anthony Ogunfeibo is the founder and Editor of www.alternativeanalyst.com a value investing website. His goal is to set up an investment fund which will acquire cheap assets and allocate capital to undervalued companies with durable competitive advantages.
