Monday, December 17th, 2012

Euro-periphery: the New Emerging Market

Emerging markets are back in fashion. Our global equity models in sterling and US dollars have both increased their exposure significantly in recent weeks. But the appeal of emerging markets also depends on the availability of alternatives in the domestic equity market. Eurozone investors seem less inclined to play in this region and we don’t think this is because they are late to the party. Europe has enough emerging market stories of its own.

The parallels between the euro crisis and the Asian currency crisis in 1996 have been pushed too far. It’s a mistake to think that the same policies could or should be prescribed now as 17 years ago, or that they would have the same effect. The demographics, social security systems and industrial bases are so different. But there is one great similarity: real estate crashes, banking crises and equity market collapse – and the nature of the recovery process.

Politicians and economists tend to think in terms of the right policy mix and improved regulation, but markets are simpler than that. There comes a time, despite – not because of – all the rescue packages, when it can’t get any worse. Volatility stops rising and then starts to decline. Lower risk arrests the panic selling. Market makers who are short have to buy in stock, and then we get the first wave of speculative buying. This is a market process, not a set of policies. Analysing the policy mix, is just an exercise in retrofitting the data. These recoveries are almost impossible to predict from fundamentals. They can only be observed in real time.

Few sophisticated investors are surprised when this process occurs in traditional emerging markets. So why are they surprised when it happens in Greece, Spain and Portugal? It’s not that long ago since these countries were also regarded as emerging markets. Eurozone investors don’t need to invest in emerging markets, because they can buy the same risk return profile without leaving their currency bloc.

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