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Emerging Market to Outperform Western Economies in 2012

Tuesday, 21 Jun 2011 07:34 AM

For the last six weeks or so, we have seen a correction in the global stock markets as well as in commodities across the board. Emerging markets were underperformers in 2011. The question is: Who will recover faster once this downtrend stabilizes?

There are a few reasons why emerging markets should grow faster in the near future. The sell-off in commodities can have a negative effect on some countries that are heavily dependent on it for export (Russia) but others could benefit.

India and China are two of the largest economies which will benefit from lower commodity prices. Easing inflation will allow the central banks of China and India to take their foot off the brake.

With the valuation of emerging market stocks being low, one can expect that money sitting on the side lines will flow into emerging markets, after a sell-off of commodities.

While some emerging markets might be hurt by the next leg down of the commodities, others might actually benefit from it. The inflation fears that have spooked financial markets might prove to be short-lived.

Another possible explanation to the better-than-expected recovery is that emerging economies have low vulnerability to country indebtedness.

The DJ Euro Stoxx 50 – the index for Europe – has a heavy weighting of financials such as banks and insurance companies which have hundreds of billions of euros exposed to Greek, Irish, Spanish and Portuguese debt.

The S&P 500 also has a heavy weighting of financials who are exposed to real estate and mortgage debt. While quite a few emerging economies have a large trade surplus and big foreign reserves, both the United States and many other Western countries have no such luxuries and are heavily indebted.

In addition, while Europe and Japan have an aging population, emerging economies tend to have a young population which will help them grow faster.

China is expected to grow at a much faster pace toward the last quarters of 2011 compared to Europe, Japan and the United States.

Most emerging economies are still in need of big investment in infrastructure unlike Europe or the United States.

For example, Brazil is investing heavily in airports so as to be able to meet the domestic demand as well as a heavy influx of tourists for the World Cup and the Olympic Games.

Brazil is also building new roads, rail tracks and ports to be able to meet increased Chinese demand for natural resources such as iron ore.

China is building more and more highways as well as high-speed trains as its population is demanding a more comfortable mode of transportation than bicycles. India is also seeing a surge in demand for cars and air travel. Indeed, in a few years China will have more cars than the United States.

With a sharp increase in intra – BRIC trade (for example, a huge take off in Brazil China trade) and less with aging debt-ridden Western economies it is more and more likely that we see a disconnect in future trends. While Japan, Europe and the United States might continue to have slow growth and high unemployment, emerging markets economies will recover much faster.

For example, if one looks at the iShares MSCI Emerging Markets Index ETF (EEM) Index, one can see a drop of about 8.6 percent from its high point in April. Vanguard Emerging Markets ETF (VWO), which has a different composition of shares, dropped a bit less, 7.97 percent. This correction is a bit stronger than the Dow Jones Industrial Average, which dropped from its high in April by about 7.62 percent (from a high of 12,873 to 11,897).

Investing part of one’s portfolio in a broadly diversified global emerging market index such as MSCI Emerging Markets (there are several ETFs that duplicate this index like EEM or VWO) might help one’s retirement fund stretch longer.

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