Diary of a Hedgehog: Biggs' Final Words on the Markets

The Canary in the Coal Mine?

February 10, 2011

Emerging markets (EMs) topped out last fall and bumped sideways through the end of last year. Since then the index has dropped about 9%. This damage isn’t too bad in absolute terms, but versus the S&P 500, EM has quite dramatically underperformed since October as the chart on the next page shows. The index line has fallen further than shown in the past day.

As the second chart indicates, over the long run these vicious potholes in EM relative performance versus the S&P have occurred fairly regularly although the current one is quite severe. The chart is also interesting in that it shows that on a relative basis the EM index is back to the same level it was at in mid-2007. I still believe that since the developing world is where the growth is and since its valuation by most criteria is lower, in a bubble-prone world awash with liquidity, eventually EM will be the bubble of all bubbles. Just for the record, at the end of last week based on analysts’ consensus, bottoms-up 12-month forward earnings estimates EM was at 11.2 versus 13.5 for the U.S. and 11.1 for Europe.

As I’ve written previously, the principal reason for this fade is investor fear that EM central banks are still early in a tightening interest rate cycle because of rising inflation. However, I did not expect the reaction to be this severe. The biggest cause of this inflation is soaring food prices as shown in the third chart. What a spike! The index is up 64% from its low ...