Worry spreads to emerging markets

Mon Aug 18, 2008 2:23am EDT
By Jeremy Gaunt, European Investment Correspondent
LONDON (Reuters) - Investors enter the week in a mood of increasing nervousness about the global economy, with deteriorating growth in the United States, Europe and Japan now beginning to bite into once high-flying emerging markets.
It is a concern that was underlined last week when MSCI's benchmark for emerging market stocks .MSCIEF hit its lowest level in nearly a year, taking the index down around 28 percent from its all-time high last November.
The emerging market index, moreover, has been underperforming its developed market counterpart, even though that too has been battered by the credit crisis and ensuing economic slowdown.
While developed stocks as measured by MSCI .MIWO00000PUS have lost around 9 percent over the past two months, emerging markets are down 13 percent.
Some of this is the result of normal trading patterns in which emerging markets outperform when risk appetite is high and underperform when, as now, it is low.
But it also reflects a growing belief among investors that the world economy in general is at risk, and with it the emerging markets that have been a powerhouse of growth and investment gain over the past few years.
"Certainly weaker euro zone economic growth, weaker U.S., weaker UK is bad news for emerging markets," said Gabriel Stein, senior international economist at investment advisers Lombard Street Research.
"I would be surprised if we don't see some weakness over the next six months, if not faster than that," he said.
A key area will be the so-called BRICs emerging market powerhouses, better known as Brazil, Russia, India and China. Although growth remains robust in all four countries, there are some signs of trouble.
China, for example, has seen factory output slowing on weaker export demand while India is expected to miss the central bank's growth target.
Hong Kong, something of a proxy for Chinese exporting, said on Friday its economy shrank by a seasonally adjusted 1.4 percent in the second quarter, as exports and consumption slowed sharply.
"The global economic and financial turmoil is starting to take its toll," said Rob Subbaraman, economist at Lehman Brothers.
COMMODITY BACKTRACK
One spillover from this has been the tumble in commodity prices. Oil, for example, has fallen more than 20 percent from its record high above $147 a barrel about a month ago, partly on the assumption that demand will slow.
Similarly, the industrial metal copper, used for power and construction, has fallen about the same amount since the beginning of last month.
Such falls, which will continue to be an investor focus this week following sharp moves last week, have prompted investors to cool their concerns about global inflation.
Some 49 percent of respondents in Merrill Lynch's August poll of fund managers, for example, said that they now expect global inflation to be lower in 12 months' time. Two months earlier, 59 percent were expecting it to be higher.
If inflationary pressures do ease, that will free central banks to take actions such as cutting interest rates to stimulate economies. Any expectations of that should boost government bond demand and could give equities a lift.
Lower commodity prices, meanwhile, are a mixed bag for emerging markets, cutting revenues in producing countries but easing domestic food and energy prices.
"There will be winners and losers," said Jacqueline Aldous, head of research at investment firm Crosby Forsyth. "You've got a range of countries that are commodities and oil plays such as Brazil and Russia, and Asia which is a purchaser of oil."
A changing economic environment will change investor perceptions accordingly.
U.S. KEYSTONE
The increase in investor concerns comes primarily from the spread of economic woe that first showed up in the United States into other major economies.
Data last week showed the euro zone joined Japan to move half way into a recession -- technically defined as two successive quarters of growth contraction -- after its gross domestic product fell in the second quarter.
The broadening of economic woe has made U.S. assets more popular, boosting the dollar as overseas investors have bought in as a safe haven play and U.S. investors have returned home.
With the dollar index .DXY, a gauge of the greenback against a basket of major currencies, rising around 5 percent over the past two weeks alone, investors will be particularly focused this week on currency fluctuations.
There may also be some search for signs that the U.S. economy is stabilizing just as the rest of the world is beginning to hurt.
Housing has been the trigger for much of the U.S. economy's pain, but two consecutive U.S. housing reports over recent weeks have been better than forecast.
Financial markets, accordingly, will be braced for Monday's National Association of Home Builders report and Tuesday's release of housing starts and permits for July.