The Hindu Business Line : Market View

The monetary easing in the United States all of last year was benefiting emerging market stocks in particular. This was consistent with the classic late-cycle story of liquidity chasing an increasingly limited number of opportunities, thereby driving valuations of the growth segments of the market higher and higher. Growth and momentum metrics performed the best in terms of relative stock performance under a decoupling regime.

What fundamentally changed the scenario in November 2007 was a marked pick-up in inflation across emerging markets and the resultant wave of aggressive Central Bank tightening. Valuations almost always compress during rising inflation periods and growth and momentum strategies perform very poorly. In the developed world, an increase in the inflation beyond 3 per cent has traditionally led to lower price-earnings ratios, with a 1-3 per cent inflation rate typically marking the sweet spot for equities. Inflation kills most bull markets: the first major emerging market bull-run in the early 1990s also met its demise when inflation accelerated to an average rate of over 30 per cent in developing countries. Central banks then were forced to aggressively tighten monetary policy. Inflation is nowhere near as serious an issue today; the headline rate of 6.5 per cent in emerging markets is still quite low when viewed over a longer time frame. The commodity-induced headline inflation is so far not leading to runaway wage growth, thereby preventing a price-wage spiral. On balance, there is no reason to believe that the secular bull-run in emerging markets is over.

Morgan Stanley Growth Fund Newsletter

That the growth rate in GDP will be lower in FY 09 is not a surprise, as we had highlighted this prospect in our India 2008 document and earlier, too. The macro-environment is not as conducive as it was in December when we articulated the view that GDP growth rate may decline yet stay in the 8 per cent plus level. Will GDP trend even lower, given changing circumstances? The estimates from sell-side research are increasingly pointing to such a denouement. The range of the expected number is wide. The odds of a slump are low. The fiscal stimulus — excise duty cuts, income tax relief, implementation of the Sixth Pay commission and liberal government spending ahead of elections — is likely to largely neutralise the emerging sources of strains, especially. Consumption may get a leg up and may cushion the GDP growth rate on the downside.

Sundaram BNP Paribas Asset Management

More Stories on : Mutual Funds | Outlook

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page