Thursday, April 17, 2008

Emerging Economies - A Simple Graphic

Here's a great graphic I grabbed from a site called Visualizing Economics. It's another, really simple way to think about where capital is currently chasing returns. Investors are seeking outsized returns in the "Emerging economies"because the "developed" world is currently reverting back to its long-run mean return. The long-run average return from 1926 - 2006 was about 6% in the U.S., so the end of the most recent and protracted "bull cycle" has implied very low returns going forward. The S&P 500 is down about 10% for the year so far.

As the graph clearly shows, the economies growing the fastest are pretty well correlated to population growth in those areas. Correlation is not necessarily causation, but sometimes, it's more than enough. Where there's smoke, there's often fire.

Chasing returns in emerging markets is no different than when companies search for growing markets to sell its products in. It's simple, as this graph shows, and makes sense. The bigger question is whether "decoupling" is real. Many believe globalization has led to a world that has "decoupled" from a U.S. Emerging markets will therefore still expand despite a US led economic slowdown, so the theory goes. But if we are buying more of China's goods and services than we sell them, then who is replacing our purchases? Maybe the better question is, if decoupling doesn't play out, then what do all of these people do when their standard of living doesn't rise due to stalled growth?

Decoupling may just be wishful thinking. Only time will tell.

1 Year Chart, S&P500 vs. iShares Chinese (FXI) and Indian (IFN) Market ETFs

6 Month Chart, S&P500 vs. iShares Chinese (FXI) and Indian (IFN) Market ETFs