Emerging Markets Will Not Fold
11/22/2010 12:25 pm EST
Despite the sell-offs and the rate hikes, the longer-term bull trend remains intact, write David Fuller and Eoin Treacy of Fullermoney.
Markets seldom move in a straight line for very long, so after 12 consecutive weeks on the upside some reaction was due. The question today is, how extensive a pause are we likely to see?
With global stock markets, we are looking for some mean reversion toward the rising 200-day moving averages. This would most likely result in a combination of smaller (less than 10%) reactions for the less overextended share indices. Some of the more overstretched indices could see somewhat bigger pullbacks, qualifying as corrections.
If these are normal pauses and consolidations within cyclical bull markets, as we think, then we should see more ranging than trending within the short- to medium-term patterns that now occur.
Meanwhile, we are somewhat less concerned about a slowdown in gross domestic product growth in the emerging (progressing) economies. Yes, interest rates are rising, but they are still negative relative to rates of inflation. However, at some point rising rates will move above inflation in the progressing economies, creating a stiffer headwind for GDP growth and therefore corporate profits.
We are also less concerned about the initial rise in long-dated government bond yields, which have been at historically low levels in the West and therefore were unsustainable for any environment other than the double-dip recession, which appears to be a diminishing risk for the main economies. Furthermore, additional evidence of gradual economic recovery would probably prompt some investors to switch a portion of their capital from bonds to equities, extending the cyclical bull market.
Euroland's debt problems in its Mediterranean states and Ireland remain serious and are therefore still capable of some occasional psychological influence on stock markets in countries further a field. However, they are unlikely to weigh on progressing economy growth prospects.
Lastly, commodities have retained their reputation for volatility, and outright corrections have already occurred in some instances. Gold remains a notable exception, although it, too, is susceptible to mean reversion. With less froth in commodity markets, at least for a while, the realization of investors' worst fears about resources inflation have been postponed.
The continued recovery in the global economy is highlighting disparity in performance between high-growth regions in Asia and Latin America versus comparatively sluggish growth in the US, Europe, and Japan. A one-size-fits-all approach to monetary policy is not suitable to such conditions. Record low [interest rates] are simply not appropriate for high-growth regions where inflationary pressures are increasingly evident. A number of countries have begun to normalize policy this year; however, the pace of advances has been slow primarily due to the upward pressure such a widening of interest rate differentials has on the respective currencies.
Commodity-led inflationary pressures have once again moved center stage, and while most are now pulling back from their recent highs, the medium-term trend remains skewed towards higher prices. This suggests that Asian and Latin American economies will have little choice but to continue to raise interest rates, making further attempts at capital controls more likely.
Brazil has, so far, been the most high-profile country to state it will limit the advance of its currency, but more countries are now also taking substantive action. The corollary is that a disorderly US dollar decline is becoming increasingly unlikely.