Friday, February 06, 2009

Decoupling Of Markets Is Not A Myth

Decoupling - can the rest of the markets decouple from the US markets. That topic has been debated to death. The firm answer is that, yes markets have actually decoupled judging from the history of the last 8 years. However that seems to work only when we are in a flattish or bull market environment. The massive correction over the last 8-9 months have shown how all markets have recoupled during bad times. During the global bull market from '03 to '07, many pundits believed that developed and emerging markets outside of the US were strong enough to not catch a cold when the US sneezed. The BRIC countries of Brazil, Russia, India, and China were probably the most talked about countries when "decoupling" came up, but as we've all seen, these countries have in fact gotten hit much harder than the US during the downturn. A main pillar of the decoupling belief is the view that China and the other emerging market economies in Asia will maintain their impressive growth momentum despite a slowdown in the Western industrialized economies.

This couldn't be highlighted better than in the chart below that shows both the US and the BRIC countries as a percentage of world market cap since mid 2003. As global equity markets rallied across the board from '03 to '07, the US lost a huge amount of world market share, falling from about 45% to a low of 24%. At the same time, BRIC countries went from about 4% of world market cap to nearly 16%.


Latest - Wow! Look at the yen/dollar rate go ... from 89.4 to 91.7 ...


Once the credit crisis hit, however, US markets fell, but the rest of the world fell even harder. And as the chart shows, the US has been steadily gaining back market share over the last year or so, while the BRIC countries have fallen. When there are massive corrections, it looks like the BRIC countries and the rest have nowhere to run, especially when its a crisis with global effects.

Just because the markets recoupled during bad times does not debunk the decoupling theory. Its an indication that the theory needs to be refined and is not a one dimensional rule of thumb. Despite the US losing some of its pre-eminence in economic leadership, the aggregate demand by the US is still the engine of global trade. Yes, the dominance by US consumers may have been easing as a percentage over the last ten years, but its still the most significant demand factor today. Decoupling does not mean that an American recession will have no impact on developing countries. That would be daft. Such countries have become more integrated into the world economy (their exports have increased from just over 25% of their GDP in 1990 to almost 50% today). Sales to America will obviously weaken. The point is that their GDP-growth rates will slow by much less than in previous American downturns.

Globalisation has taken strong roots over the last 10-15 years, and that basically means more open economies to trade. BRIC countries have been able to build up wealth faster as they can run up greater surpluses and their companies can see strong profit growth, and thus the trickle down effect. Add in their huge requirement for infrastructure, its a potent mix. The recoupling during a bear market may only be in effect if its a "globalised event". If its a localised event, the decoupling theory may be able to hold up much better. But the key question now is whether any correction nowadays will be a localised event for the US. The answer is probably not.

Globalisation has in effect seen a surge in the freer flow of funds to invest in global assets. They could be index funds, commodity funds, hedge funds, private equity, etc... hence when US catches a cold, the likelihood of a domino effect is very likely. In fact, recent history has shown that when things are bad, even the good assets and performing assets will be used to cover the holes and anticipated drawdowns.

The first chart basically showed that in good times, emerging markets grew much faster as trade between themselves have grown to be a lot more important relative to the US. This shows that in good times decoupling theory works well and works better. During bad times, the flow on negative effects from the US would cloud the prospects of all countries, in particular this credit crisis which is global in nature as the deleveraging process hits all countries and almost all asset classes - be they good or bad.

The chart at the bottom proves once and for all that decoupling works well when things are going well, a reflection of the higher growth beta of emerging markets. But when things are bad, beware, its not a time to only look at how wonderful your local economy is doing.


p/s photos: Park Eun Kyung


see said...

I wouldnt say decoupling yet. It boils down to the question of how much the middle class has grown in emerging markets to develop its domestic demand.

As to growth in emerging markets due to more trade among themselves, should look at ultimate destination of those intra trade. Is it ultimately the US which is the buyer? Things are now more of a global supply chain. Nuts made in China, bolts in Korea, all parts assembled in Europe, final goods sold to the bingeing US consumer? The melamine scare is good example. Contaminated raising agent used in locally made biscuits......we are still coupled

solomon said...

Likely that a decoupling process is in the making but not a total decoupling as at now.

Globalisation may encourage a balanced sharing of economic and politic power between the 3 continents (America, Asia and Europe). But, this could be remain a dream until the emergence of a continent that have the purchasing power as good as US. This likely to explain why a strong dollar policy is favour by the US.

A good analogy is that when u have 3 buddies walking, you need a leader who guide the rest. Same here, when you are the proclaimed leader like US in the past, do you want to reliquish the leader armband? Unlikely lah.