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The Great Debate

QE2 to speed triumph of emerging markets

By J Saft
October 12, 2010

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.

Comments
5 comments so far | RSS Comments RSS

Wouldn’t QE2 be like pouring water into a cracked pot?

Emerging economies do not need the boost.

A sense of panic obviously prevails in the developped world, and little correction is made where discipline has been lacking eversince the start of globalization, and all this will eventually give protectionism a good name.

Posted by Neander | Report as abusive
 

The huge mistake of this approach is to assume that every organization on the planet that can rent a Post Office box in Manhattan is “American”.

There is no need to perform US taxpayer funded quantitative stimulus of foreign countries or of the many companies claiming to be “American” but working to export jobs rather than goods from the USA. The obvious way to do this is to make money diverted to foreign investment from the US Treasury subject to a 200% excise tax. The same with money invested in foreign currencies, bonds, or other securities.

If you take US Government stimulus money, you invest it here. Or do not take it because it will cost you dearly. Companies paying the excise tax should be barred from US Government contracts for five years in addition. Smack ‘em!

Posted by txgadfly | Report as abusive
 

I do not support contributing and investing in “emerging markets” at the expense of direct investment in the United States of America. “By emerging markets”, I assume you refer to a blanket that includes India, Malaysia, Thailand, Cambodia, Vietnam, Laos..etc. First off, each one is a separate case. A few words on Thailand. In the case of Thailand, for example, the listed shares of the preponderance of companies on the SET are closely held family and related family owned and controlled shares. Many are interlocking with other companies. “Audited” statements are frequently done by one man offices with virtually no transparency and no ability to perform due diligence. Extensive boards of directors are drawing substantial salaries to hang around all day at spas and clubs, golfing, and shopping. The people working in these companies are barely being paid wages that make ends meet. much of the goods and services portfolio has some sort of black economy behind it. Parts, components, counterfeit parts, cut and past packaging in small subcontract black shops with child labor and human rights abuses. There is a total absence of the concept of R & D, lip service is occasionally paid to something called Corporate Social Responsibility, but it amounts to advertising versus real action and programs. The graft and corruption and the skim or vigorish lift off from any deals is monumental. Foreign companies go along with the “payoff”, because it’s the only way to do business in Thailand, and this is a big problem. The university educational system is totally broken and a sham, and there goes the future talent pool. The currency has been orchestrated and manipulated stronger by the elite establishment as a cool way to invest overseas in London, New York, Los Angeles and other world cities in Europe where the Thai Baht now buys 25% more foreign currency than four years ago. They are getting the money out of Thailand. The country is on the verge of constant civil unrest, violent bombings, mass killings in the south, and frequent random bombings and grenade attacks in Bangkok. The sanctioned black market in counterfeit goods, child pornography, prostitution, and intellectual property is staggering. Informed local sources put the prostitution and by products (drugs and money laundering) at a staggering scale and large percentage of “official” GDP as it filters back in to the networked and linked companies of the elite establishment. The infrastructure is a nightmare in Bangkok- the hub and center of the universe of power and control- The roads, electrical, and telephone wiring throughout Bangkok looks like a bowl of Spaghetti on every pole on the two main drags and all the little old fashioned side streets. The flooding is a horror eight months out of the year, and scientists predict, and Thailand themselves reports frequently that Bangkok will sink into the sea in ten years. Censorship is deplorable, pervasive, and oppressive. At least 60,000 web sites have been shut down, they have a huge budget funding a battery of we site police. Other news sources say the web site closure number is closer to 120,000. Do you want to invest in such an opportunity where a major event could precipitate a possible civil war at any time? Notwithstanding that ultimate likelihood, does the business opaqueness and black economy appeal to you? Then Thailand’s for you. They are waiting and eager to always take your money and side step terms of agreement after the fact. You are totally helpless and rendered irrelevant.It’s a disaster waiting to happen. A military elite establishment cross between an oligarchy and a kleptocracy. Good luck with your investments in Thailand – they are smiling and waiting for your money.

Tom,
Bangkok Thailand

Posted by cutusbudget | Report as abusive
 

txgadfly

And how do you propose to monitor your smart ideas?

The U.S. Administration can’t even handle what’s going on in its mortgage books; if you had read the foreclosure articles.

And people who have access to QE would have all the ways and means to launder it. Tracing it would be a nightmare.

And it’s hard to understand why giving away money can create jobs when most of it is used for speculation which in turn creates more bubbles and ensuing problems.

But then, there’s nothing much the U.S. government knows it can do.

Posted by doctorjay317 | Report as abusive
 

True. Yet there are a couple of things to consider.
1)What we hear again is actually the same old story. Yes, the story of “this time it’s different”. Just listen carefully to all those stories about “decoupling” and the “new world ahead of us”, “new normal”. Sounds very much like the stories we have heard so many times before. Those stories about “huge investment opportunities” in emerging markets actually imply that in 2007 some low-hanging fruit was left unnoticed. Why? And what has fundamentally changed? Brazil still has 20 percent illiteracy and China’s workforce is still predominantly undereducated… In
2) The truth is simple: the US, and the West in general, need asset bubbles/inflation/appreciation in emerging markets. In other words, we need a catastrophe there so that we may look more attractive. We need everyone to be blind so that we, the one-eyed, might be the king. That is the purpose of the QE. The problem is that also the emerging countries in Asia and elsewhere have been there before, in 1998 and they do not agree…

Posted by tk2 | Report as abusive
 

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