QE2 to speed triumph of emerging markets
While “decoupled” is not the same as “immune”, look for growth and investment performance in emerging markets to be better than in the sclerotic developed world.
In the short term emerging markets will be free riders as the U.S. launches the second round of quantitative easing. A portion of the stimulus generated by “QE2″ will inevitably leak cross border, while the risks of the gambit will fall almost entirely on the U.S. and on dollar-denominated assets.
QE2 is designed to work in two ways: to stimulate investment by making it cheaper to borrow money and to lift consumption by boosting asset prices.
To the extent it succeeds a goodly portion of that consumption will be goods and services purchased by the developed world from emerging markets.
As for investment, in the absence of capital controls U.S. corporations that choose to invest using borrowed money can be counted on to put a lot of the money to work where opportunities are best: emerging markets.
These facts – that emerging market countries enjoy advantages in production and have better outlooks for growth and investment going forward – argue that any strategy aimed at reviving economic growth will by definition benefit emerging markets, perhaps disproportionately.
A recently published book, “The Day After Tomorrow” (http://blogs.worldbank.org/growth/node/8745 ) by Otaviano Canuto and 40 fellow World Bank economists argues that developing countries are becoming the new locomotives of global growth, a trend which will be long lasting and growing in strength.
The book forecasts growth in the developing world at 6.1 percent this year, 5.9 percent in 2011 and 6.1 percent in 2012. In contrast, the forecast is for growth of between 2.3 and 2.6 percent in the developed world in the same period. On this reading emerging market GDP will actually be larger than that of the developed countries in 2015, a milestone that a decade ago would have seemed a pipe dream.
The book lays out the standard arguments for the trend, but they are compelling nonetheless. Technology will transfer and be adapted faster, so-called South-South trade between emerging markets will take off, the middle class will bloom and, crucially, a leaner balance sheet will allow for more and better yielding investment in infrastructure.
A MONUMENTAL BET
Despite this you could make a case that the biggest single bet in financial markets today is an unwitting and unintentional bet against emerging markets by developed markets investors.
Despite accounting for close to half of global production, emerging market equities are only about 30 percent of global equity capitalization. So if an investor has a benchmark weighting in emerging markets, they are by definition underexposed to emerging economies.
That is not the half of it though. Institutional investors have only about 6.0 percent of their equity holding in emerging markets, a screaming underweight bet. Of course this does not reflect a negative view. It is because of a shortage of emerging market shares and a legacy of a home bias towards holding shares in ones own currency.
So, here we have the recipe for major out-performance: the growth is coming from emerging markets, there is constrained supply and everyone is terribly under-exposed.
Goldman Sachs is forecasting a tripling of exposure by institutional investors to 18 percent by 2030, by which time it expects developing nations to account for more than half of global market capitalization.
That means not just appreciation but a wave of share offerings, many of which doubtless will be somewhat dubious, just as happened during the dot com boom. It is also a certainty that shareholders will be abused, their rights trampled on by government and insiders. Lots of scandal, lots of outrage, but probably lots of profit too.
Europe, Japan and the United States have aging populations, many of whom have not saved sufficiently for their retirements. It will not be too long before they come to accept that slow growth is a feature of their home markets, rather than an aberration. With growth scarce in the developed world, the price of growth in emerging markets will rise, driving price earnings multiples higher.
Will there be a bust if QE2 goes wrong or if growth in the north turns negative again? Almost surely, but there are good reasons to think the recovery will be stronger and faster in emerging markets.
Is there reason to worry about a bubble? Probably, but given the alternatives investors will likely be better off betting on the balancing of the global economy than sitting this particular dance out.