The bulls feel their time has come again. After years in which the time of debate has been set by those worrying about the US trade deficit, and loose monetary policy, some are now starting to talk about a new “golden era”.
A key component in the bullish case has been the turnaround in the fortunes of the emerging markets, led by China. From being simply a free rider on the back of global growth, emerging markets have turned, say the optimists, into a significant positive factor.
Anais Faraj of Nomura believes the world economy has experienced a structural break that will lead to high growth and modest inflation. “Global productivity is rising as economies like Brazil, India and China enter the mainstream. As a consequence, inflation in the major markets continues to fall. We appear to be repeating the benign “golden age” cycle that spanned 1955-74.” He says the world economy is not dependent on the US consumer. Instead, growth and investment flows between emerging markets are now the driving force.
All this, Faraj believes, will be very good for financial assets. “Global liquidity is abundant, capital expenditure and consumer demand is rising, corporate balance sheets and efficiency look better than they have for a long time and interest rates are low” he says.
Another strategist who sees emerging markets in a positive light is Eric Lonergan of Cazenove. He argues that emerging markets are a lot stronger than they were in either 1994 or 1997-1998. They have current account surpluses, net external assets and cheap currencies. This reduces the chance of a widespread emerging market crisis, removing a significant source of instability from financial markets.
Lonergan says that these improved fundamentals have been reflected in emerging market bond spreads, but not yet in equity prices. According to his figures, emerging market shares offer a risk premium of 3 percentage points over global shares, compared with roughly zero in the early 1990s.
For the bulls to be proved right, we will probably need a couple of years of solid global growth, without any crises in the foreign exchange or bond markets, caused by a falling dollar or rising US short rates.