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Are Emerging Markets Decoupling from the Developed World?

Our generation has seen and heard its fair share of bunk economic theories. These are high-sounding theories that are often touted by recognized investors or higher learning institutions - and for that reason, they mostly remain unchallenged. At the top of the list is economic decoupling between emerging and developed countries.

How have emerging market countries faired this year? Is there any evidence they are decoupling from the rest of the world? And how can investors make informed and profitable investment decisions in this particular category?

Emerging Markets

Countries that are in the midst of rapid business growth and industrialization are generally referred to as 'emerging markets.' With a combined population of almost 2.5 billion people, China and India are among the largest emerging market countries.

The theory behind economic decoupling is that emerging market countries can prosper and remain unaffected by adverse financial conditions elsewhere, particularly developed countries. Decoupling has been heavily promoted over the past several years, especially by academic types in the mainstream press.

While decoupling may sound like a plausible idea, the performance for emerging market stocks this year doesn't support that view.

Emerging market stocks (NYSEArca: VWO) are down 16.50 percent year-to-date compared to flat performance for U.S. stocks (NYSEArca: SCHB) and a 10 percent loss for developed stocks (NYSEArca: VEA).

What about mega emerging market countries like Brazil, Russia, India, and China? As a group, BRIC country stocks (NYSEArca: BIK) are down 14.90 percent since the beginning of the year.

Stocks in India (NYSEArca: INDY), Russia (NYSEArca: RSX), and Brazil (NYSEArca: EWZ) are in bear market territory, down between 20 to 30 percent in value. Based upon the stock market's performance, the theory of economic decoupling isn't holding up and neither is the argument of a soft landing.

Slowing Growth

The high octane growth from emerging countries that analysts have been preaching is not as high or as fast as previously thought. China's Consumer Price Index ( CPI ) and Producer Price Index (PPI) for November were a big disappointment. The year-over-year (y/y) results were weaker than projected.

CPI was ahead just 4.2 percent compared to 5.5% in November 2010 and PPI for the same period was 2.7% compared to 5%. Also, declines in both China's CPI and PPI were worse than what economists were projecting.

CPI measures the changes in the price of goods and services bought by consumers, while PPI measures the changes in the price of goods and services sold by producers.

In the manufacturing sector, China's growth has slowed to its slowest level in two years and home sales along with exports are ebbing. Premier Wen Jiabao's formula to save China and the rest of the world by creating a lending boom is both odd and unimaginative. The strategy did not work in developed economies like the U.S. - and won't work elsewhere. (See the horrific results of former Federal Reserve Chairman Alan Greenscam's decision to keep interest rates too low for too long.)

Crisis Doesn't Play Favorites

Europe's financial crisis has taught us that a financial crisis doesn't take a holiday nor does it play favorites. The problems that began with fringe countries like Greece and Portugal have now infected France and Germany. How does this relate to emerging markets?

Emerging market countries are not invincible, as the enthusiastic academics paint them to be.

Interestingly, a Bloomberg poll of global investors showed that 61 percent expect a financial crash and banking crisis in China by 2016. The poll's respondents are probably right, with the exception that a Chinese blowup may not take as long to unfold as they assume.

Sixty-one percent of respondents said they anticipate a crash in the financial industry by late 2016, and only 10 percent were confident China's banks will escape trouble, according to the quarterly poll of 1,097 investors, analysts and traders who are Bloomberg subscribers conducted Dec. 5-6.

Nevertheless, there are a few holdouts.

Economists from Goldman Sachs and the International Monetary Fund, still forecast China will avoid recession and keep a lid on inflationary pressures. A report from Goldman Sachs in early December projected China's GDP growth of 8.6 percent for China in 2012. To achieve results like that, China has zero margin for error.

Conclusion

Rather than buying into the popular theory of economic decoupling, we encourage investors to analyze the facts and remain skeptical.

ETFguide'slatest Weekly ETF Pick evaluates emerging markets by evaluating credit growth, trade flows, and the interdependence of these countries with their trading partners. A clear path for investing in emerging market ETFs is given with a short-term outlook and entry/exit points for capitalizing.

Ron DeLegge is the Editor of ETFguide.com and Author of 'Gents with No Cents: A Closer Look at Wall Street, its Customers, Financial Regulators, and the Media' (Half Full Publishing, 2011).

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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