Don't Sweat the Emerging Inflation Scare

02/14/2011 12:26 pm EST

Focus: GLOBAL

David Fuller

Global Strategist and Producer, Fullermoney

Shanghai stocks are showing resilience already, and Bombay’s will come around in due time, writes David Fuller of Fullermoney.

A deflationary depression was never likely to be the outcome following the most massive monetary stimulus in history. Instead, every central bank erred on the side of inflation in response to the credit and insolvency crisis that created severe recessions in many economies, particularly in the West.

As the global economy recovered, led by Asia and the resources exporting countries, inflation has surfaced. Inevitably, these cost pressures are more apparent today in the stronger economies, of which China is a leading example. The problem has also been aggravated by La Niña, which has damaged many agricultural crops over the last nine months and counting.

I maintain that today's inflationary pressures are a bigger problem for government bonds than equities, particularly in the West, where long-dated yields fell to historically low levels in 2008 and 2009. Equities are a partial hedge against inflation, provided monetary measures to contain it do not combine with rising costs to create a clear threat to corporate profits.

Commodity prices have not reached the heights that we saw in the first half of 2008, but they are still rising. Consequently, they will remain a concern for financial markets. Fortunately, growth remains a priority in both the emerging economies and the West. This may moderate upward pressure on short-term rates, particularly in the West, where core inflation remains low as wage pressures are minimal.

Clouds Lifting in Shanghai

Meanwhile, China's Shanghai A-Shares index has absorbed a lot of negative sentiment, so I am interested to see that it has risen on seven of the last eight trading days, which span the Chinese New Year Break. [Make that eight of nine after Monday’s 2.5% jump—Editor.] The overall pattern looks like an extended base formation to me.

India's government has certainly not distinguished itself recently in dealing with corruption and food price issues. This has hastened an exodus by investors during what has also been a logical but I believe temporary fashion trend away from emerging markets and in favor of Wall Street and other developed-country stock markets, from Germany to Japan.

The fundamental catalyst for this change in sentiment has been the surge in food prices and higher interest rates. The big correction in India's stock market is also creating a buying opportunity for investors who share our long-term views.

India is a high-beta market. Last year it was revered, this year it is feared, so far. Savvy long-term investors lighten on strength, if they are going to lighten, and buy on fear.

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Down But Hardly Out in Bombay

If every stock market index looked like India's Sensex, I would say we were in a global bear market, although one likely to be a lot smaller than 2000-2001 or 2008-2009, because we do not have the same bubbles or fraudulent banking activity today. Fortunately, not every stock market index looks like India, which is suffering from the government's mistakes, and these have aggravated food price inflation and understandably increased concern over corruption.

Since food-price inflation is a global problem that is predictably getting worse before it gets better, those buying India on this weakness may wish to do so incrementally, on a scale-down basis. We do not know when the global food price surge will top out. However India's own crop cycle may be the greater influence on its stock market, in addition to perceptions regarding governance. In inflationary terms, might India be first in and first out?

[John Bollinger is bullish on Shanghai, Tokyo and overseas stocks in general, while Jim Jubak argues that India and other emerging markets could drop further still as foreigners head for the exits—Editor.]

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