Best Financial Markets Analysis Article The western economies led by the United States are teetering on the brink of recession, which is expected to be followed by a prolonged period of slow growth if not something worse namely stagflation.

Meanwhile the emerging economies continue to consolidate their strong growth rates, buoyed by huge trade surpluses from strong exports of consumer goods and raw commodities enabling governments to embark on huge infrastructure building projects. These economies are increasingly feeding their domestic construction and consumption booms as the developing world continues to make the mega shift to the developed world.

Whilst the mega growth trend is strong across the emerging markets, going forward not all countries are expected to keep up with the same degree of growth momentum as many emerging markets continue to peg their currencies to the US dollar which is contributing towards surging inflation that has been followed by higher interest rates which further increases the pressure on the currency pegs that results in higher money supply growth rates that cycle back to higher forward inflation and interest rates.

The only clear solution for the emerging market countries is to gradually break their ties to the US dollar, this will have the consequences of lower inflation and lower interest rates thus sustainable economic growth. Many emerging markets are already on the path towards revaluation of their currencies as evidenced by the 13% appreciation of the Chinese Yuan during the past year.

Its not all bad news for western investors, for currency appreciation adds to portfolio gains for investments in emerging markets with strong currencies, thus foreign investors are receiving both exposure to the strong economic growth and capital gains from appreciating currencies.

In the meantime talk of a US dollar bottom seems premature, yes maybe the euro has run too far too fast, but the emerging market currencies rallies against the dollar to date have been very measured and controlled. Any bottom in the US dollar cannot be countenanced until the US economy shows signs of a turnaround and US interest rates rise. So despite rising US inflation the US Fed will be restrained when it comes to raising interest rates until the economy is strong, and that will not happen until the credit crisis is over as there cannot be a strong US economy until the banking sector shows recovery and starts lending again. Even then emerging market currencies will continue to have a comparative trend advantage given the degree to which the currencies have been kept lower against the US dollar.

Major Emerging Markets

Russia / Central Asia

Russia continues to benefits from commodity price boom resulting in fast paced economic growth rate of more than 7% which rivals that of the current power houses of India and China, whilst russian stocks remain comparatively cheaply priced on a Price earnings ratio of just 12. The best sectors remain oil and gas, which has in recent years begun to feed through to a wider consumer boom as the country plays catchup. As a mega trend Russia is one of the few countries that is expected to benefit from global warming as the perma frost melts and more land becomes available for both exploration and utilisaton for farmland in a time of a growing global food crisis. Resources hungry China will increasingly become a client state for Russia in terms of energy and food supplies, and thereby closer links in the east will ignite a boom in the east of the country that may re-shape the face of Russia as population expands in the vast Siberian frontier. Meanwhile Europe is increasingly held to ransom to Russian oil and gas supplies which gives the Russians great leverage in future favorable trade negotiations and treaties with the European Union.

As Russia grows more powerful economical the expectation is that its leaders will exert more pressure on the satellite EU states such as the baltic states and Poland possibly including the use of its fast growing Sovereign Wealth funds in addition to oil and gas as a large footstep into Europe both for commodity supplies and later for manufactured goods as production shifts eastwards from Western Europe to Eastern Europe into Russia. All of which suggests Russia is an re-emerging industrial super power that has the majority of the requirements for sustained strong economic growth for many years.

Going wider afield from Russia the other central asian commodity resource rich markets such as Kazakhstan also look promising though carry more risk in terms of political instability.

China

Whilst the growth rate for China is still expected to be strong, I believe the best years are now behind China as it meets its capacity constrains of a large population and lack of arable farming land and natural resources which will mean the inflation genie will be hard to control. There's is also the uncertainty of what happens when totalitarianism meets the aspirations for freedom amongst a growing middle class that is destined to number more than 400million, especially given the growing wealth gap between the coastal regions and the more impoverished inland regions which has historically resulted in the destabilisation of China .

Also global warming works against China as the deserts expand in the face of rising temperatures, therefore future growth rate is expected to be at the lower end of the emerging markets scale.

The Shanghai Index is down some 52% from its October 2007 unsustainable highs, and therefore much of the over valuation that I warned of at the time has now evaporated. Still on a PE ratio of 25, the market has further room for more downside, perhaps a further 25% off which given anticipated GDP growth rate of 8% would make the Chinese stocks appealing for the long-run.

India

India has the benefit of being about 10 years behind China along the development curve, and also seen as being politically more stable, don't be confused by the history of political infighting for they tend to result in a more robust government that is better able to withstand dissent without cracking, unlike China and many other emerging markets.

Therefore, India has more potential for a stronger growth rate than China going forward, however it faces similar problems to China with regards food and fuel inflation and lack of resources, therefore it no longer ranks highest on the potential growth chart that follows towards the end of this article. The BSE Index stocks are far cheaper than China 's and therefore suggests downside in India is more limited than that for Chinese stocks.

The Gulf States

The oil rich Gulf states look set to continue to boom as the petro dollars flood in. Whilst not democracies, the sheikdoms have been around long enough to have developed some degree of competency in future planning for the day when oil supplies start running out. These countries also have a great advantage over the likes of other emerging markets such as China or India in that they are self sufficient in oil. I.e. as domestic demand grows as the economies grow, so will exports reduce as oil is diverted towards meeting demand from domestic consumption. This also implies dire consequences for western economies that rely heavily upon oil imports, which means that even if oil production rises over the coming years the actual amount of oil available on the open market will contract.

Those looking for slow down in the west to bring oil prices back down, are not factoring in the explosive growth of demand as the worlds middle class is set to double from 1 trillion to 2 trillion in a short space of time, these new consumers are increasingly wanting the same facilities that westerners take for granted which includes cars.

Of the gulf states , the United Arab Emirates is fast becoming the financial centre of the region and may one day rival the likes of London and New York as Dubai attempts to take the crown from its local rival Bahrain.

Africa

The majority of African emerging markets are starting from a much lower base, and therefore present the potential for substantial growth, however time is a factor here as it could take economies anywhere from 3 years to 30 years to be able to reach critical mass in terms of igniting explosive growth rates for countries such as the Conga, which has the potential to rival any of the gulf states in terms of economic growth and wealth if it is able to overcome political instability and corruption, the safer option may be to rely on South Africa as a vehicle into Africa.

Latin America / Brazil

Latin America has vast untapped resources and a pool of well educated populations, where the only thing the countries have lacked in the past is economically competent governments. The shift towards democracy is starting to pay dividends in many of these countries, coupled with booming commodity markets enables countries such as Brazil to emerge from the rainforest into a cash rich economy that is well on the path towards becoming a developed nation. As with the gulf states, the advantage to Brazil is its rich resources that will enable the country to continue to prosper during the resource conflicts of the future that have the potential of bringing the likes of China down to a crashing halt. Unfortunately this optimistic picture is reflected in the Brazilian stock prices that have soared ahead whilst other markets have plunged, therefore it's a question of timing ones entry to avoid paying too much which will be covered in an update to the global stock markets outlook.

Therefore, emerging markets investment should be geared in favour of commodity rich economies that are already well on the development path to utilising their wealth wisely towards a programme of build infrastructure and industry to enable the countries to continue growing beyond peak oil.

Emerging Markets Investment Rankings and ETF's

For entry timing watch out for an update to global stock markets outlook as the forecast period for last analysis of 25th March 2008 comes to the end which gave the overall trend for global stock markets for a rally from March 08, into early May, and then followed by a decline into late June towards the March lows, therefore the potential exists for an time window with favorable market entry prices.

The following graph covers 16 of the worlds global stock markets and illustrates my current view on future growth expectations from which market is considered cheap and which is expensive . This article continues in our current free weekly newsletter.

By Nadeem Walayat

Nadeem Walayat has over 20 years experience of trading, analysing and forecasting the financial markets, including one of few who both anticipated and Beat the 1987 Crash. Nadeem is the Editor of The Market Oracle, a FREE Daily Financial Markets Analysis & Forecasting online publication. We present in-depth analysis from over 150 experienced analysts on a range of views of the probable direction of the financial markets. Thus enabling our readers to arrive at an informed opinion on future market direction. http://www.marketoracle.co.uk

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any trading losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors before engaging in any trading activities.

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Comments

Sophie
20 Jun 08, 17:50

India / China

I believe you have these two the wrong way around. China still offers far more opportunity than India.

China is strong whilst India is inherently weak and subject to crumble at the next economic crisis. Not every country wants a weak democracy !

I agree with your assessment on Russia, this is a sleeping bear that is starting to wake up.

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