Goldman Sachs released an institutional research report last
week titled "Emerging Markets: As the Tide Goes Out," in which they
warned that this area of global growth will not only continue to
disappoint next year, but for a surprisingly long time.
In fact, the report predicts "the strong possibility of significant
underperformance and heightened volatility over the next five to 10
The authors recommend that investors with just a "moderate"
tolerance for risk cut their EM exposure by at least one-third,
from 9 percent to 6 percent of overall portfolios.
The scope of their timeline for EM underperformance surprised me
because I thought that global growth over the next decade would be
driven by billions of EM citizens aspiring to urban middle-class
From a CNBC.com article summarizing the GS view...
"Goldman Sachs used the 59-page report to argue that growth in
emerging markets from 2003 to 2007 was a result of specific
economic circumstances that aren't likely to be repeated; the
political and economic reforms needed to improve growth are too
painful to undertake.
Common themes in Goldman's pessimism on countries like China,
Brazil and Russia include overinvolvement of governments in their
economies, increasing reliance on commodities and unfavorable
Goldman notes that China has five main problems...
1. Severely imbalanced growth
2. Weakening demographic profile
3. Financial repression that has distorted allocation of capital
4. Growing pollution that has endangered the health of its
5. Antiquated household registration system known as 'hukou' that
has hampered access to education and social services
And an even bigger China bear growled last week too. According to a
Bloomberg article, when Deutsche Bank equity strategist John-Paul
Smith looks at the country, he says he detects some of the same
signs of a financial meltdown that led him to predict Russia's 1998
stock market crash months in advance.
"China's expansion is being fueled by soaring corporate borrowing,
a high-risk model that needs to be replaced by the kind of
free-market measures and budget cuts that fed Russia's growth in
the aftermath of the country's default and subsequent 44 percent
monthly tumble in the Micex Index, Smith said."
I think this China/EM question will be one of the top 2 or 3
investor topics of 2014, because further equity weakness and
possible financial/systemic issues, as repeatedly highlighted here
by Tracey, could ripple over to our shores.
I have two questions for you...
1) Do you think Goldman is being extreme with the 5-10 year
underperformance call for EM? Read their list of China's "five main
problems" again before you answer because the demographic issue
might be the linchpin we hadn't considered, on top EM governments'
biggest challenge that "the political and economic reforms needed
to improve growth are too painful to undertake."
2) In the most optimistic light, how long can the Chinese
government prevent or postpone systemic financial fault lines from
becoming a mega-quake? Clearly there will be growing pains in a
rapidly emerging economy like China's and it seems like the
variables for their central bank to control are far more complex
than the ones our own Fed faces.
Few investors believed the Fed could pull off what they did in the
last 5 years without creating run-away inflation. Our faith in PBOC
wisdom and skill must surely be far lower, or cloudier.
Let's pick up where Tracey's
China in a Credit Crisis
left off and keep this important discussion going for the next few
months -- at least until I revisit it!
ISHARS-EMG MKT (EEM): ETF Research Reports
ISHARS-BRAZIL (EWZ): ETF Research Reports
ISHARS-CHINA LC (FXI): ETF Research Reports
NASDAQ-100 SHRS (QQQ): ETF Research Reports
SPDR-SP 500 TR (SPY): ETF Research Reports
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