The last week has seen contagious and
discontinuous market swoons rile global investors,
policy makers and pundits. The Hang Seng and
Shanghai gyrations have been stomach turning.
European and Asian markets have delinked,
relinked, delinked and tumbled. The only
consistent trend is down, down, down.
Multiple theories have been fed through
the meat grinder with the allocations they
inspired. Trillions of yuan, US dollars, yen and
euros in paper wealth have been transformed into
fuel for a fear inferno. Of course this will not
last forever. Time will salve wounds and leading
firms and prudent long-term plays will eventually
emerge. Our first order of business must be to
understand what is
actually happening. The first
casualty of fear is perspective. Let’s try to zoom
out, take in the action and figure out what is
going on. For the past three years, non-US
equity market’s returns have handily outperformed
US returns. This is compounded by the prolonged
slide in the dollar. Since US financial trouble
began to dramatically unfold in the summer of
2007, many developing markets continued to trend
higher. China has been a leader of this charge.
The growth in Brazil, India, China and Russia - or
BRIC - has been spectacular over the past few
years. As a US-led global slowdown loomed, these
traditionally delicate emerging markets continued
to outperform.
If we use broad ETF
(exchange traded funds) as proxies for
emerging-market performance, we see clearly that
these markets have been doing better than the US -
even before adjustment is made for increases in
their currencies against the US dollar. The 10%
increase in value of the yuan against the dollar
and the performances of the Hang Seng Index and
Shanghai Composite Index are dramatic.
The
ETF funds of Latin America, Asia ex-Japan and
emerging Europe have all outstripped the US
benchmark S&P 500.
Part and parcel of
this outperformance has been belief that these
economies are poised for rising international
import and new era growth. IMF data make clear
that in 2007, India and China accounted for more
global growth than the US.
I don’t doubt
that the future global economy will be far less
US-centric. I don’t doubt that GDP growth will be
more rapid in the emerging markets over many of
the coming years. I do doubt they can magically
delink from trouble in the US and Western Europe.
The US, Western Europe and Japan still account for
over 50% of world GDP and over 70% global market
capitalization.
Part of the carnage of
this week has been the realization that delinking
theories are delinked from history, economic
analysis and common sense.
At the same
time as this decoupling fantasy was hit, further
fallout from US financial and debt loss overhang
became clear. This week we have also begun to see
the first announcements of losses from Chinese
banks. The Bank of China, Industrial and
Commercial Bank of China and China Construction
Bank are all believed to have losses from assets
links to US mortgages. The US$7.9 billion being
discussed now is clearly an early conservative
estimate of value at risk.
The slide
toward recession in America gained momentum as
Treasury Secretary Henry Paulson and President
George W Bush pushed fiscal policy stimulus and
further weak corporate earnings were announced.
Growth slowdowns call into question high energy
prices, commodity price highs and asset
bottom-feeding. We are clearly not done with
credit-related problems and attendant economic
weakness. This added fuel to fear’s fire and
quickly spread.
Fears of further losses
from credit market turmoil and asset write downs
riled Asia, South America, Europe and beyond.
Lower euro-zone growth estimates and downside risk
awareness in Europe’s markets led to volume asset
sales. This further spooked Asian investors as
Europe has become an even larger trade partner
with China than the US. Investors have been
selling in Asia, Europe and the US at different
rates for different but related reasons for the
last week.
World central banks - save for
the US Federal Reserve - have not responded for
fear of stoking inflationary pressures and being
seen as narrowly subservient to financial markets.
Thus, there has been a delinking of coordinated
central bank liquidity policy as global markets
melt down. The loss of concerted action by central
bankers has added more fuel to the fires.
Asset prices are burning down. Price
movements have been bizarre since Friday January
18. Normal correlations and lock step movements in
global markets have come unglued. Asian shares
trade differently in NY and Hong Kong. European
shares trade differently in Asia, New York and
Europe. The divergence of course means that market
openings are expected to price heavy action
elsewhere and influence tomorrow’s action
simultaneously. The first sign of calming will
be movement toward harmony across markets’
direction and magnitude of change. I will be
scanning the smoky horizon for coupling of market
movement.
Max Fraad Wolff is a
doctoral candidate in economics at the University
of Massachusetts, Amherst and managing director of
GlobalMacroScope.
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