Emerging Market Recovery

Stocks have now advanced around 35% from their lows in early March. The Dow and S&P indices are down only in the mid single-digits for the year while the Nasdaq is actually up 5%. I fully expect that we will give some of this back. It is normal for the markets to bounce around like this when the market is making a bottom. Volatility will remain high and the market bounces will be erratic and chaotic until the economy is clearly in recovery.

The emerging markets are beginning to come back to life especially China. The government’s massive stimulus program has helped China avoid sliding into a very severe recession. The Chinese economy is not hampered by many of the same problems plaguing the U.S. The state-dominated economy was able to successfully implement a massive stimulus program in November and without any delays started massive infrastructure projects. This has partially offset slumping export of Chinese goods. One note of caution, in order for China to have a sustained rally, demand for Chinese products from the rest of the world must begin to recover.

In addition, Chinese consumers are very thrifty and are not burdened with heavy debt unlike their western contemporaries. So Chinese consumers are unencumbered by large credit card bills, loans and/or mortgages and are starting to spend again.

The emerging market stock exchanges have moved up sharply maybe a little too sharply in recent weeks. The MSCI Emerging Market International ishares (EEM) are up almost 13% year-to-date. This recovery has been very rapid but the fundamentals do not support such a large swing. I would not be surprised if we gave some of this back.

The Chinese have historically been ravenous consumers of commodities. A rapid recovery could spark an increase in commodity prices and inflation. Currently, we are in a slightly deflationary environment but this could change if demand for commodities increased rapidly. It is difficult to tell if the rally in China and other emerging countries is sustainable. At least the panic is over and the global economy can begin to heal. As the recovery takes hold it will be important to closely monitor commodity prices for signs of inflation.