Thursday, June 26, 2008

Did the IMF blow the emerging markets bubble?

Sometime in late 2007, a ‘new paradigm’ seemed to have emerged; that of fast-growing developing markets to trade at a premium to the developed world. I was in India in December 2007, and was often befuddled at some of the articles and conversations I came across. Indeed, brokerage houses pompously proclaimed the dawn of a new era in emerging markets. Investors, it seemed, would pay up for the faster growth, disregarding country risk, currency risk, inflation risk, home bias, etc. Truly, a ‘structural change’ seemed to have occurred.

Fast forward six months, and it’s a completely different cup of tea. A lot of ink has been spilled on the under performance in the emerging markets YTD. Some reasons discussed include:

-Increased risk aversion (flight to quality).
-Credit crunch induced liquidation of assets.
-Commodity inflation induced price shocks.
-Reversion to the mean in valuations.
-Reversion to the mean in profit margins.
-Decline in cost competitiveness due to commodity inflation, local currency appreciation and increasing labor costs.
-Debunking of the decoupling theory.
-Uncapitalistic regulatory and price control regimes.
-Political upheaval due to upcoming elections in India.
-*Insert favorite reason here*

Well, how about a new one?

In January 2008, IMF came out with a now forgotten report titled “Global Growth Estimates Trimmed After PPP Revisions”. The report trimmed the annual global growth estimates between 2002-2007 by 0.5% each year, definitely not a ‘rounding error’! More importantly, the contribution to the global output from China went down from 15.8% to 10.9%, and India's contribution was revised from 6.4% to 4.6%: a downward revision of almost 30%!!

Here's an interesting chart from the IMF report:

Quite interestingly, countries whose contributions held steady seem to have outperformed those who faced downward revisions.

If you look at the table above, India (INP) and China (FXI), two countries where the contribution percentages went down sharply, have underperformed in 2008. On the other hand, Japan (EWJ) and Brazil (EWZ), where contributions were (marginally) revised upwards, have held up rather well.

Is this merely a coincidence? While I don’t know the answer to the above question, it's certainly a good one to ask.

Parting thoughts: what are the possible implications of this 30% downward revision on the current commodity super cycle boom? A case maybe of going too far too fast?

Ticker symbols discussed: SPY, FXI, EWJ, EWZ, INP

Full Disclosure: None