Recession in the US or not, emerging markets look good

Recession in the US or not, emerging markets look good

London: Think the US will skate by with only a slowdown? Buy emerging markets. Cash rich and largely untouched by the debt and housing debacle undermining confidence in the US, emerging markets are also insulated by locals newly flush with money to spend, making them less dependent on demand from the US and Europe.

Also, emerging market investments will benefit from past and future cuts in US interest rates which, while designed to cushion a slump at home, will support already strong growth in places such as India and Russia.

Two years ago, you would have been laughed out of school for advancing the so-called “decoupling" theory—that developing countries can do relatively well regardless of the fate of the world’s largest economy. The theory was always that when the US sniffles, the rest of the world takes to its bed. But the debate has shifted, as borne out by relatively strong and resilient performance by emerging market assets during times of extreme turbulence elsewhere.

The Morgan Stanley Capital International (MSCI) Emerging Markets Free Index of global equities has risen by more than one-third so far this year, and 14% since just before markets began to wobble over the summer. In contrast, the MSCI G7 index of developed countries is more than 5% down since the fireworks and up a little more than 2% for the year. But, can emerging markets continue to outperform?

“It is a very good bet," said Stephen Jen, currency strategist at Morgan Stanley in London. “It’s an extraordinary conclusion that no one would have drawn two years ago." Which is not to say that in the event of a hard landing, emerging markets would go up and up unscathed but, rather, that they would tend to outperform.

Jen also cautions against the possibility of steep falls in Chinese shares and property, either of which could hurt demand and confidence. But a key plank supporting emerging markets performance is strong investment flows from developed markets, which analysts see as a permanent shift, rather than the usual chasing of hot returns.

Morgan Stanley estimates that net portfolio inflows into emerging markets are $50.2 billion (Rs1.98 trillion) this year, against $15.2 billion in the same period a year ago and $12.5 billion in 2005. It is also arguable that emerging markets, which collectively have a large current account surplus and enormous foreign currency reserves, are less vulnerable to both a credit crunch and a sudden pullback from risk.