More pain in emerging markets but isn't that a good thing in the long run?

01/27/2010 9:42 am EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

The correction in the world’s emerging stock markets continues.

At noon in London today, January 27, the MSCI Emerging Markets Index was down 0.5%. That brings the index’s six day retreat, the longest slide in a year, to 7.8%.

There’s just enough news of tighter lending from China and signs of higher interest rates from Brazil and other emerging economies to keep markets on edge. As of noon in London the MSCI Asia Pacific Index was down 1.1%. The eight straight days of losses is the longest losing streak since May 2005. The Shanghai Composite Index was down 1.1%.

The worry on China is that curbs on bank lending, which have seen some of China’s biggest banks effectively stop lending, and increases to reserve requirements will go too far. The government wants to take some of the air out of speculative bubble in real estate and stocks and temper the recent trend toward higher inflation. Investors don’t really know how far the tightening will go.

 But it’s important to remember, as you try to figure out China’s stock market for yourself, that markets always go to excess.

 In a bubble that excess is on the upward side. At a time like this it’s on the downside. The Shanghai Index, which has dropped below 3,000, is now below its 200-day moving average for the first time in two years.

I certainly understand the fear—exactly, in my opinion, the kind of stock market reaction Beijing hoped to induce by its recent moves--but I don’t see a change in the economic or monetary fundamentals in China. And on past history the Chinese government isn’t likely to let this slide go so far as to damage economic growth.

China’s markets aren’t the only ones falling right now. The Bombay Stock Exchange lost 2.9% on fears that this week’s meeting of the Reserve Bank of India will result in higher reserve requirements for banks. Brazil’s central bank will probably leave interest rates alone at its meeting but signal that it will increase rates as early as April in an effort to keep inflation from hitting 5% by the end of 2010.

This short-term pain in emerging markets is, in my opinion, a good thing. In the beginning of the year investors were worried that these markets were running too far, too fast and headed toward a bubble. For the moment, at least, central banks from Brazil to India have let some of the air out of that potential bubble.

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