Are the Developing markets the saviours for the global economy?

The developing markets were considered the poor cousins of the developed economies. However with the passage of time it was realized these countries had the potential to provide a fresh impetus to economic growth in world markets. The allure of these countries was further enhanced when economists from Goldman Sachs coined the term BRICS (Brazil, Russia, India and China).These countries had all the right ingredients-huge populations, rising income levels and low penetration of necessary services like banking which made them attractive investment avenues.

The potential of these markets was further magnified when noted fund managers like Jim Rogers and Mark Mobius, the "Indiana Jones" of the financial markets stressed the return potential offered by these markets to foreign investors. The emerging markets have well and truly picked up the baton of economic growth from the developed world and gone on from strength to strength. The pace of growth in these economies has been stunning, using an adjective like "bewildering" to also describe the pace of economic growth is not entirely misplaced.

A recent report released by the World Bank confirmed what most people in the investment fraternity have believed for long. World Bank estimates show a big dichotomy in growth expectations, which can be seen by the following table:








Its no wonder the top performing equity markets globally are the emerging markets. This can be attributed to expectations of these countries filling in for slumping demand from the developed world and helping the global economy extricate itself from possibly the sharpest slump in economic activity since World War II. The following table shows year to date performance of equity markets across different regions:














Source: Bloomberg, as of June 25 2009


However it is very easy to get carried away and extrapolate the growth prospects for these economies. One needs to be a bit more circumspect when evaluating returns potential. The BRIC countries have had their share of problems for example India grapples with a high fiscal deficit and is vulnerable to any spike in commodity prices, most notably crude oil. Uncertainty over the monsoon could slightly dampen expectations, it remains to be seen how the situation evolves over the next month or so. The latest move to bailout Air India could further widen the fiscal deficit. India can ill afford largesse like these.

The emerging markets hold tremendous growth potential and should continue to provide traction to the wheels of the global economy in the future.

Is it a new dawn for the global economy?

Well this question has been one which has the analysts community split right down the middle. I belong to the camp which believes there are still lower lows waiting to be hit across the spectrum of asset classes, be it stocks or commodities. The recent rally has made the sceptics camp look dumb, as a gush of liquidity led to a rocketting of prices across asset classes.

Are we really on the cusp of a rekindling of the growth story in the global economy? I think its too early to tow that line of thought. Albeit its emergin market economies have witnessed stellar runs, supported by enhanced liquidity and expectations of economies like India and China being the growth engines for the global economy. The fact that developed world economies like the US and the Euro zone are still plauged with problems tends to get overlooked. The US still faces the problems of a huge deficit, while the Euro zone is likely to encounter stress from problems emanating from its banking system.

Clearly, the basis for the present rally across asset classes has been injections of massive liquidity. Several global economies have witnessed stimuli from governments in one form or the other, which has helped arrest the decay in economic activity. The sustainability of the present rally remains questionable.

True the emerging markets have been at the forefront of this rally, but they still have their own vulnerabilities. Lets take the case of China and India. Though the dragon has well and truly stirred, China remains an export oriented economy. A significant share of its export trade is with the US, a cooling off in demand could lead to a slowdown in the chinese financial system. The Indian case is interesting, as the allure of the country has increased manifold after the thumping win for the Congress led alliance in the recent general elections. Its very easy to extrapolate expectations and re-rate asset classes. The Indian story looks to have seen a sustainably positive turn, however the rating of markets has been devoid of sanity as too much has been discounted too soon.

In my view, we could be on the verge of shocks. Markets have a tendency to surprise on the opposite side, much to the chagrin of investors. An example here can be the US Dollar. The whole world had a unanimously bearish view at the beginning of 2008, and what did the greenback do? It rose sharply through the year. Are we in for a dejavu? A couple of other indicators point to this too. Risk aversion which is represented by the VIX index looks to be in the process of forming a bottom. A sustained rise in the VIX is dangerous for stocks and commodities due to an inverse correlation. The Japanese Yen, another safe haven instrument in turbulent times could appreciate further and retest the low set at 86-87. The Dow Jones Index has been unable to convincingly breach key resistance levels, which suggests investors are cautious.

Where do we go from here? I believe stocks and commodities could retest their lows and even go lower from there. To cite an example of Crude Oil, i believe crude oil should test between USD 76-78 and then start falling. Purely on a technical basis, a new low could be in the offing. Or would it? Only time will tell....