It doesn’t make much sense to talk about emerging markets anymore. Nor can we lump the markets of the fast-growing Bric economies (Brazil, Russia, India and China) together. The world today is divided not into developed and emerging markets, but into commodity producers and consumers.
Consider the once-fashionable Bric markets. The Morgan Stanley Capital International Bric index shows a gain of 3.0% for the month of May. But that number conceals widely divergent performances. While the MSCI index for India was lower by 6% and the index for China lost 5.4%, MSCI Brazil gained 7.3% and that for Russia rose a huge 15.7%. While the Sensex, the benchmark index of the Bombay Stock Exchange, is down in the dumps, Brazil’s Bovespa index reached an all-time high last month. And it’s not just the stock markets, but the currency markets are also diverging. Returns from MSCI India in dollar terms fell by 10.34% in May, much more than in local currency terms, as the rupee depreciated against the dollar. On the other hand, the Brazilian currency has appreciated, boosting dollar returns from MSCI Brazil to 11.39% last month.
Could Brazil and Russia have outperformed simply because they, based on their stock price against estimated earnings, are much cheaper than the Indian or Chinese markets? That could be part of the reason, but markets such as Indonesia, Malaysia, Thailand and Mexico are also very cheap and their performance has been nothing to write home about.
Simply put, the Asian markets are underperforming because they are commodity consumers, while Russia and Brazil are doing well because they are commodity producers. On a larger canvas, it’s the broad reason why the MSCI index for Asian emerging markets is down 9.8% this year, while the Latin American index is up 8.5%. And, although the underdeveloped Arabian markets have not done well this year, Saudi Arabia’s stock exchange surpassed London in the number of initial public offerings during the first five months of the year. Even the markets of resource-rich Norway, Sweden and Australia were all in positive territory in the year to 30 May. Consider MSCI Canada, up 8.1% this year, against a negative return of 4.1% for MSCI USA. Money is flowing not only into commodities but also into anything that’s associated with commodities, be it the equity markets of commodity producers or their currencies.
Those who predicted that the credit crisis in the West would lead funds to flow out of the credit markets into emerging markets were wrong, but only partly. The money has instead flowed into commodities and to commodity producing markets. The reasons are simple: the cheapening of the dollar by a series of rate cuts has fuelled commodity inflation. Commodity prices are inversely correlated with the strength of the US currency, as commodities are considered to be a hedge against the declining purchasing power of the dollar. Small wonder that investors have flocked to commodities, with speculators quick to join the party. They have been helped by ample liquidity, the result of the reluctance of central banks to tighten in the face of higher inflation. That has resulted in real short-term interest rates turning negative in markets ranging from the US to China, Japan, India and many other Asian countries. And finally, the relatively strong performance of the Indian and Chinese economies has kept the demand for commodities high.
Nevertheless, a few straws in the wind now point to a change of direction. One of them is the new-found strength of the US dollar. The price-adjusted major currencies dollar index, which had dropped to a low of 78.99 in March, is now back up to 80.08 and some pundits are calling a bottom for the dollar, on the premise that the US Federal Reserve is done with cutting rates and signs that the growth slowdown is spreading to Europe.
Another signal is the fact that the metals have seen a correction. As on 27 May, The Economist magazine’s metals index was lower by 4.6% compared with a year ago. As research outfit Gavekal has pointed out, final demand for many industrial commodities has been slowing, particularly since mid-2007, because of slowing global growth. The Economist’s food index, although higher by a huge 54.9% than a year ago, has lost 0.7% in the past month, with some commodities such as wheat taking a beating. But inflation is being pushed higher by the non-food agricultural commodities and by crude oil, the price of which has doubled in the past year. Interestingly, a recent study by Mecklai Financial finds there is a comparatively lower negative correlation of crude oil prices with the dollar index, which means the supply-demand balance has a greater role to play in crude prices.
In the final analysis, though, isn’t the demand for commodities linked to how strong global growth remains? China and India are widely expected to slow down, the latest data from the US shows continuing fragility and there are signs that Europe and the UK are beginning to wilt. Some Asian countries are cutting back on oil subsidies, which should raise domestic prices and lower demand.
In these circumstances, will commodity prices, including oil, continue to hold their ground? A report from BCA Research puts it succinctly: A slowing in non-G7 economic growth at a time when the US is still weak could be the catalyst for the long overdue correction in commodity prices. But till that happens, the split in BRIC between BR and IC will continue.
Manas Chakravarty looks at trends and issues in the financial markets. Your comments are welcome at firstname.lastname@example.org