How far has the credit crisis in the mature markets affected other markets? One way of answering that question would be to look at some of the market indices before the credit crunch first hit the equity markets—say 25 July—and compare where those indices are currently. Considering the horror stories we’re being told about the crisis—the huge losses in the banks, the seizing up of the interbank markets , the estimates of more than $350 billion (Rs13.79 trillion) going down the drain and dire warnings of a US recession—we should have seen a panic rush to safety by investors dumping risky assets.

So, have government bond prices been bid up as a result? They certainly have and the Citigroup World Bond index was at 728.4 on 12 December, 8.5% higher than its level four-and-a-half months back, on 25 July. That’s well above the return on equities—the MSCI World index increased by a mere 1.6% between 25 July and 12 December.

Bonds have become the preferred choice for investors in the developed world, compared with equities. That’s very different from the way things were before the credit crisis hit. Till 25 July, for instance, the MSCI World index was up 10.3% (between 29 December 2006 and 25 July 2007), while the Citigroup World Bond index was up 2%.

By 12 December, however, the MSCI World index was up 12% year-to-date, while the Citi Bond index had almost caught up with the return on equities and was up 10.7% year-to-date.

Moreover, the MSCI World index disguises the real impact on the equity markets of the developed world, because the returns are skewed on account of the inclusion of the emerging markets. If the MSCI index for the developed world is considered, the gain has been a mere 0.5% between 25 July and 12 December. And Europe’s FTS Eurofirst 300 index has shown a negative return of 1.6% over the period. It’s ironic that, even though the source of the credit crisis has been the subprime mess in the US, Europe seems to have borne the brunt of the fallout.

The carnage in the credit markets is best seen from the credit default swap spreads. These widened in Europe from 36.1 on 25 July to 56.4 on 12 December, as shown by the iTraxx Europe index of investment grade corporate debt. Similarly, the North American CDX Investment Grade index spread widened from 56.6 to 83.3 over the same period. Volatility in the US market, gauged by the VIX index, is up from 18.1 to 22.5. Interbank lending rates, seen from the London interbank offered rate (Libor) too have moved up sharply.

The EMBI+ index, which tracks emerging market bonds, rose 5.9% between 25 July and 12 December, but emerging market equities did better, with the MSCI Emerging Markets index going up 10.8%. Year-to-date, the MSCI EM index is up 39.4%, while the EMBI+ index is up 6.4%.

Some of the best performers have been the Sensex, which went up by 29.8% between 25 July and 12 December. China’s SSE A index was up 17.9% over the same period. The oil-exporting markets have done even better, with Saudi Arabia’s Tadawul index moving up 44.4% during the period.

What conclusions can be drawn from these trends? In the developed markets, investors have moved away from equities to the safety of government bonds. That’s a clear sign of rising risk aversion.

However, emerging market equities, also traditionally seen to be risky assets, have done very well indeed, so far. That could be a reflection of the belief that these markets are “decoupling" from the developed markets. The surprise is that not only have emerging market equities done well, but have performed better than emerging market bonds.

Surely, if there’s a flight from risk, emerging market bonds should do better than equities.

Perhaps the recent drops in emerging markets are an indication that their outperformance has been temporary and they may have a long way to fall.

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