Monday, August 24, 2009

Emerging markets: “new era” bubble talk is back.

In the final phases of a bubble’s blowoff, the talk of new paradigms and global tectonic shifts comes into vogue. One hallmark of the emerging markets mania back in 2007 was the bubble talk that went with it(See my post here). China and India seemed like failsafe can’t miss destinations.

Well, looks like some of it is back. Look at this article for instance. Here’s an interesting chart from the same.

Let’s consider the data from 2003 to 2008 (A very short span of 5.5 years):

Share of World GDP:
Chinese GDP went from 4.4% of global GDP to 7.3 %, or a rise of 66%.
Indian GDP went from 1.5% of global GDP to 2 %, or a rise of 33%.

Share of World market capitalization:
Chinese market capitalization as a share of world market capitalization went from 1.1% to 7.1% , an increase of ~545%!!!
India's share went up from 0.9% to 2.8%, a rise of 211%

The stock markets in India and China have gone up almost 8-9 TIMES their rise in the share of world GDP! The author completely side stepped this issue, as well as  the issue of valuations.

A similar argument can be made on the "new era" talk of China surpassing Japanese stock market capitalization. This fails to take into account the deep-value nature of the Japanese market right now. (A lot of Japanese companies trade below book value).

While a lot of effort has gone into bearish prognostications about China in Q4 of 2009, a similar case can be made for India as well. A year back, I had written about the bear case on India. With the failed monsoons, sagging rural demand, hike in taxes, and a lack of  reforms, I am currently extremely bearish, and a bear case part 2 can certainly be made right now.

One might be tempted to argue that these markets are fairly valued since their share of global market capitalization is now similar to their share in global GDP, but the reality is that emerging markets come with their own set of idiosyncratic risks: lack of transparent accounting, insider manipulation, lack of real shareholder ownership, and government interference, to name a few. I would argue that their share of global stock market capitalization should be well below their share of global GDP. This is an extremely important and contentious argument that needs to be revisited. (Note that people like Jeremy Grantham actually disagree on this one).

For now, suffice to say, bubble talk is back.

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