A Look at What’s Ahead for Emerging Markets

by Inya Ivkovic, MA

To understand what lies ahead for emerging markets for the rest of 2009, it might be beneficial to revisit where they have been in the past quarter. In the second quarter of 2009, global equities rallied off their mid-March lows. One plausible scenario is that investors around the world started believing in the concerted efforts of world central banks and that they would actually be able to prevent the financial collapse and that equity markets could be trusted again. Another reason for renewed confidence were indications that the decline in global economic output was stabilizing, if not improving, particularly in the U.S., despite the dismal labor data coming from nearly every corner of the world.

But the more reasonable explanation came from China itself and the country’s steady improvement of macroeconomic data. In a mere four years, China managed to surpass Japan as the world’s second largest economy, while its role on the global stage has become increasingly important. This is hardly surprising, considering the size of China’s economic stimulus, equaling a whopping 16% of GDP, with monetary policy easing significantly all the while. At the moment, these efforts seem to have taken effect and are holding.

One particularly relevant piece of good news concerning the emerging markets recently was the rebound in the commodity markets. Crude oil futures gained over 41% for the recent quarter, while copper, which commodity traders often call as their “chief economist,” considering the metals’ forecasting ability, increased 23% in price. Many believed the run-up in commodity prices was due to China’s hoarding of commodities and unleashing it inventories during the second quarter. However, other explanations are also possible, such as that investors still fear inflation and could be running towards physical assets.

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Of course, the $1.3-trillion question is: will this growth and market performance in the emerging markets be sustainable? Until recently, economists refused to consider the possibility of emerging markets “decoupling” from the developed world. Now, not only are they acknowledging that the possibility of decoupling is real, but they’re also saying that, if anyone is going to be leading the world out of the Great Recession, it will be China.

But I’m not convinced. Aside from internal problems that China faces and that I discussed in one of my previous PROFIT CONFIDENTIAL articles, I don’t see how China can recover without the developed markets. Massive fiscal and monetary stimuli worldwide are likely to shift the global economy into the next gear within the next 12 months. But the events of the past year have profoundly changed the global financial systems, the appetite for risk remains at historic lows, and the world is still very much afraid of its own shadow.

Granted, on balance, the outlook for the emerging markets looks much better than for the developed markets. One of the arguments supporting this statement is that, at least for the time being, banking systems in the emerging markets have suffered significantly fewer problems than the developed markets and are in much better health, too. However, an argument against it is that the flow of international trade activity with the emerging markets has decreased significantly.

Going forward, the outlook for the emerging markets is a delicate balance between positives and negatives. On the positive side are factors such as accelerating economic activity, increased global liquidity, and higher expected equity valuations. On the negative side are concerns about the developed markets’ exit strategies (the unwinding of debt) and reawakening the U.S. consumer. Simply, the emerging markets cannot do anything until the developed world recovers enough for consumption to at least reach moderate levels.