Weekly Market Review for Week Ending 18th of May 2012
An increasingly vocal minority of market commentators are suggesting the emerging markets – and China in particular – are not the saviours of the global economy and may, in fact, be heading for a period of significant weakness. If true, this is a worrying development. Not only are many investors already holding high weightings in emerging markets, they also hold developed-world companies relying on emerging markets for growth.
Much of the anti-emerging market sentiment centres on the credit expansion in China. Fund managers such as Mike Riddell at M&G suggest there has been poor allocation of capital, with money moving into redundant housing projects. There are fears the housing market may see significant weakness as a result. The economy is slowing down already and this may yet prompt the much-feared ‘hard landing’.
Ridell also highlights a phenomenon called ‘the Lewis Turning Point’, which was identified by Arthur Lewis in the 1970s from research done on the economic history of Japan. The study found the rapid urbanisation of Japan led to a growth in manufacturing that created a virtuous circle, with falling costs spurring further growth and urbanisation.
However there comes a point when wages rise and the competitive edge disappears. For Japan, this meant a lower growth trajectory. China should have adopted this trajectory several years ago but the Communist Party has kept it artificially high through the expansion of credit. But ultimately, runs the argument, there will be a necessary period of adjustment.
Other countries have also seen a significant expansion in credit. From October 2010 to March 2011, Brazil’s credit expansion has recorded an average annual growth rate of 20.5%. Over the same period personal credit expanded 24.9% year-on-year.
However, plenty of others believe such fears are overblown. Groups such as Pimco suggest Chinese growth is slowing but not at a pace that should trigger any real fears of its collapse. Much of the slowdown in growth has been engineered by monetary tightening by the Chinese government.
Yes, concede those on this side of the argument, there are pockets of misallocation of capital but nothing to prompt a significant downturn in China’s economic prospects. They point out many emerging markets have followed orthodox monetary policy in recent years and government finances are still in more robust shape than many developed market economies.
Although many suggest the anti-emerging market view is contrarian, it is cropping up with increasing regularity, which should – counter-intuitively – give investors some cause for cheer. Emerging markets, particularly China, have not performed well in stockmarket terms and enough high-profile commentators have voiced concerns about China to suggest some weakness is already factored into share prices.