Avoid Emerging Markets Until Inflation Tamed

MSN Money February 17, 2011

2/15/2011 7:00 PM ET

By Jim Jubak

Don't get caught investing in developing markets until it is clear that interest rate hikes have tamed inflation. India and Brazil may be safe by June; other emerging nations likely have more pain ahead.

Related topics: Brazil, China, emerging markets, Federal Reserve, Jim Jubak

One and done. Two, we're through. Three, we're free. Four, no more. Five . . .

At some point, the central banks of India, Brazil, Indonesia, Turkey and other developing countries will decide that they've raised interest rates enough to combat inflation. They will see (real or imaginary) signs of the slowing economic growth they've been working to engineer, as well as evidence (significant or temporary) of slowing price increases. And then they'll call an end to a series of interest rate increases that are now at seven -- and counting -- in India and that are on track to take interest rates to 13% in Brazil by the end of 2011.

Emerging markets news

Then the fears of higher interest rates and slowing economic growth, which have been a heavy weight pushing down prices in these countries' markets in 2010 and so far in 2011, will lift. And at least some of the cash that has flowed out of the world's emerging stock markets to the stock markets of the world's developed nations will reverse course. At that point, if these emerging markets don't begin to outperform the U.S. stock market, they will at least close the performance gap that has opened in the last nine months or more.

At some point.

Of course, the big question is when this will happen. Your answer to that will determine how far into 2011 it will be before you start to move your portfolio (which you've overweighted with U.S. stocks, right?) back toward an increased exposure to emerging markets.

Jim Jubak

The answer to that "When?" is "Not yet." That's true even for the countries with the most aggressive efforts to fight inflation. For developing countries with less aggressive, more incremental policies toward fighting inflation, I'd say the answer is "Who knows?"

The nations with central banks that have most aggressively raised interest rates in this cycle -- India and Brazil -- have yet to see convincing evidence that the rate increases they've instituted have slowed growth or ended the acceleration of inflation.

In India, for example, where the Reserve Bank of India next month is almost certain to implement the country's eighth interest rate increase in the last 12 months, the economy may be showing signs of slowing. Industrial production grew by an annual rate of 1.6% in December, a big drop from the 3.6% rate in November. But many economists caution that this could result from a pattern in last year's industrial production that made it easier to beat the previous year's numbers in November than in December.

In short, the December deceleration in this one measure of growth might be a sign that the bank's interest rate increases are working, but this one figure isn't likely enough to convince the bank to reverse policy./*

In fact, Reserve Bank governor Duvvuri Subbarao recently raised his projections for inflation for fiscal 2011, which ends in March, to 7% from his earlier estimate of 5.5%.

The situation is not that much different in Brazil, which has been nearly as aggressive in raising interest rates as India. In December, Brazil's central bank raised its benchmark Selic interest rate 0.5 percentage points to 11.25%. There's no sign yet that the interest rate increases have slowed inflation. In January, Brazil's IPCA inflation index rose by 0.83% for the month, increasing the annual rate to 5.99%. The January increase matched the one in November, which had marked the fastest gain in prices since April 2005.

The annual rate of 5.99% is pushing the upper limits of the Banco Central do Brasil's inflation target of 4.5%, give or take two percentage points. The futures market is pricing in another interest rate increase in March to 11.75%, and is betting on a further increase to 13% by the end of this year.

In the cases of these two countries with aggressive central banks, the smart thing for investors to do is check back in June or so. It's quite possible that Brazilian and Indian economies will be showing clear signs of deceleration by then and that their central banks might be nearly done with rate hikes. When investors can see the end of rate increases not too far in the future, it is certainly time to think about buying.

Plenty of wishful thinking in developing nations

"When?" is harder to pinpoint for the remainder of the emerging economies, because the governments and central banks in these countries are proving to be lukewarm inflation fighters at best.

To see what I mean, take a look at Indonesia. On February 10, the Indonesian government reported that GDP grew at a 6.9% annual rate in the fourth quarter of 2010. That was the fastest economic growth in six years.

That very welcome growth rate came with rising inflation, though. In 2010, inflation was 6.96%; in 2009, the figure was 2.78%.

But while inflation climbs, the Bank of Indonesia has been extremely reluctant to raise interest rates for fear of lowering the economy's growth rate -- even though conventional central bank wisdom says cutting growth is exactly what you have to do to slow inflation. Dampening growth sooner rather than later makes it easier to prevent inflation from running out of control.

When the bank did raise interest rates to 6.75% on Feb. 4, that hike was a token 0.25 percentage points. That's not much when, at 6.50% before the increase, rates were at an all-time low. It's also not much when you consider that this was the bank's first rate increase since October 2008.

Despite the surge in inflation, and the timid response by the central bank, the economic consensus was that inflation rates would fall in the short-term, because the main rice harvest begins in March. That always leads to a decline in food prices, economists noted. But a temporary, harvest-related decline in food prices really doesn't change the inflation picture in the medium term.

Continued: The US learned its lesson in the 1970sSingle page12Next >RELATED ARTICLESJubak on video: 2 ways to curb inflationDon't sweat the global inflation scare8 ways to scratch that currency itchInvesting: Stock market, money & financial investment advice - MSN ...Money: Personal finance & investing news & advice - MSN MoneyMarket Summary - MSN MoneyVIDEO ON MSN MONEY/* /**/ var scp_UserRating=-1; down_arrow_hover= new Image(); down_arrow_hover.src = 'http://blu.stc.s-msn.com/br/scp/css/15/decoration/toolbar/rating/down_hover.gif'; down_arrow_normal= new Image(); down_arrow_normal.src = 'http://blu.stc.s-msn.com/br/scp/css/15/decoration/toolbar/rating/down_normal.gif'; up_arrow_hover= new Image(); up_arrow_hover.src = 'http://blu.stc.s-msn.com/br/scp/css/15/decoration/toolbar/rating/up_hover.gif'; up_arrow_normal= new Image(); up_arrow_normal.src = 'http://blu.stc.s-msn.com/br/scp/css/15/decoration/toolbar/rating/up_normal.gif'; var scp_thankyoutext = 'Thank you!'; var scp_thankyoualttext = 'You have voted on this'; var scp_votestext = '{0} votes'; var scp_votescount = 14; var scp_errmsg = 'Errors occured while saving your rating. 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I struggled to glean anything salient from your ramblings. 4 0ReportSpamSomeone (sheluvme) Tue 1:00 AMJIm, I must be under a rock. congrats on your new fund. you'll be getting money from me in 2011. Please get the fund available via tdameritrade or fidelity. 0 8ReportSpamvictum of the timesMon 10:11 PMThe only reason we have cheap interest rates in this country is because we gave away our economy to China and India.Otherwise,if we kept what we have given away in manufacturing and technology jobs we too would be having hyper inflation worries.But,thanks to Walmart,Tyson foods,Congress,and Slick Willie Clinton,we don't have to worry,at least not for many moons.By the way,Let's all turn our backsides to Washington and offer them a moon!It's them that control what prosperity the people have over the Corporations,or do I have that backwards? 9 16ReportSpamAdd a commentReportPlease help us to maintain a healthy and vibrant community by reporting any illegal or inappropriate behavior. 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In fact, Reserve Bank governor Duvvuri Subbarao recently raised his projections for inflation for fiscal 2011, which ends in March, to 7% from his earlier estimate of 5.5%.

"When?" is harder to pinpoint for the remainder of the emerging economies, because the governments and central banks in these countries are proving to be lukewarm inflation fighters at best.

That very welcome growth rate came with rising inflation, though. In 2010, inflation was 6.96%; in 2009, the figure was 2.78%.

Quotes are real-time for NASDAQ, NYSE and AMEX. See delay times for other exchanges.

Japanese stock price data provided by Nomura Research Institute Ltd.; quotes delayed 20 minutes. Canadian fund data provided by CANNEX Financial Exchanges Ltd.

[BRIEFING.COM] Natural resource plays led the broader market to another session of strong gains. Data had little sway with traders, though. ... More

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Avoid Emerging Markets Until Inflation Tamed

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