In globaleconomics , there are several emerging truisms. Growth
is likely to be somewhat muted in the West as efforts to reverse
massive budget deficits will create a drag as governments tax more
than they spend. A second truism: emerging market economies have
come a very long way in a very short time, and they're unlikely to
revert to their old habits that stifled growth. [See: "
Forget About BRIC -- Buy These Emerging Economies
The third truism: these upstart economies are likely to stumble on
their way to a higher plane. The biggest concern:inflation . It's
just appearing now, and could well get much worse in 2011. And if
that happens, many of the world's hottest stock markets -- many of
which have doubled or even tripled in the past two years -- could
be hit by profit-taking.
In recent days China has expressed increasing concern thatinflation
is starting to percolate. The government is seeking to rein in bank
lending and has also started to impose price controls on key
foodstuffs. But China is lucky. Itseconomy has so many hidden
strengths, its policy planners can implement measures without
pushback from independent central banks, and it is not especially
reliant on imports.
Yet many other developing economies have no such luck. They have
much less control over theireconomy and are much more exposed to
the vagaries of economic activity outside their borders. Vietnam is
a prime example. Itseconomy is likely to grow +6% to +7% this year,
butinflation is likely to exceed 10%. That's why Vietnamese stocks
have not participated in the global rally. The
Vietnam Market VectorsETF (
is roughly flat in the past year.
Risinginflation hurts equity investments in myriad ways, including:
1. Consumer activity slows as recent entrants into the middle class
find that basic staples eat up more of their paycheck. Just this
week, Brazil raised the reserve requirement for banks, which means
less money will be in circulation.
2. Governments look for ways to rein in prices by raising interest
rates, making higher-yielding emerging market debt more appealing
than emerging market equities.
3. Higher prices lead to a weakening localcurrency , so investments
translated into dollars lose value.
Risinginflation stems from a pair of factors. Economic activity
that exceeds the infrastructure that is in place, creating
bottlenecks. Think of urban traffic jams, slower factory delivery
times and an increasing shortage of reasonably-priced skilled
labor. The second factor is input prices. Rising costs for imported
oil, fertilizer and raw materials all lead to an
in prices throughout the supply chain. In many emerging economies,
both of these factors are coming into play. Cities such as
Bangalore, Jakarta and Phnom Penh have all been in the news
recently as they are starting to creak under the weight of too much
commerce and too little infrastructure. Analysts at Morgan Stanley
have already charted out the divergentinflation pictures, as seen
Yet it's thecommodity action that stands to crash the
' stock market party. Crude oil for example, now approaches nearly
$90 a barrel, roughly +30% higher than six months ago. [
Why 2011 Could be the Year of the Oil Comeback
If oil keeps rising -- past $100 a barrel -- it's hard to see how a
lot of these economies, many of which are net energy importers, can
escape the inflation bugaboo.
For oil and other commodities such as steel, fertilizer, copper,
aluminum, etc. not to see a spike in 2011, the globaleconomy would
need to putter along at a lukewarm pace. Right now, we've got
robust activity in emerging market economies and tepid economic
activity in the United States, Japan and Europe. What happens if
these lagging economies start to rebound? That's the nightmare
scenario for emerging economies, as demand for many basic materials
could quickly outstrip supply, as we saw in 2008.
Action to Take -->
Emerging markets still look like a great long-term bet, as rising
middle classes put their economies on a potentially far higher
plane. But a lot more could go wrong than right in 2011. It's been
a goldilocks scenario for several years now, with economic growth
hot and inflation cold. Signs are now emerging that the hot
economies are leading to hot action in prices as well.
If you're invested in any emerging market economies, you may want
to book profits if monthly inflation figures start to rise. And for
those not yet in emerging markets, the short side of the trade
looks better these days after stunning +100% and +200% upward
-- David Sterman
David Sterman started his career in equity research at Smith
Barney, culminating in a position as Senior Analyst covering
European banks. David has also served as Director of Research at
Individual Investor and a Managing Editor at TheStreet.com. Read
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.