As the financial crisis struck the U.S. markets in the second half of 2008, the lack of confidence reverberated around the globe as all types of risk were suddenly shunned. As has frequently been the case in these types of market dislocations, the global markets fared even worse than the U.S. markets. The S&P 500 fell 28.5% in the second half of 2008, while the Russell Developed Large Cap ex North America Index was down 36.9% and the Russell Emerging Markets Index was down 48.2% over the same six months, according to Standard & Poor’s and Russell.
Particularly in the case of the emerging markets, the “flight to quality” appears to have been largely indiscriminate and may have created an opportunity for investors with a reasonable risk appetite.
Most economists agree that any recovery from the current recession in the U.S. and most of developed Europe is likely to be a slow one, one that may take several years to regain the 2007 levels. Real U.S. GDP growth has been negative for each of the last four quarters (through June 30, 2009), and fell at a 3.9% rate for the trailing 12 months, according to the Bureau of Economic Analysis.
Forecasts for 2010 generally fall in a 2% to 2.5% range, primarily supported by government spending rather than significant contribution from the private sector. On the other hand, forecasted growth rates for many of the emerging economies are much more robust. Merrill Lynch’s most recent research report (dated July 8, 2009) is forecasting strong growth for China at 9.6%, India at 7.3% and Brazil at 4.5%.
These opportunities are supported by two main factors that have not generally been in place during past recoveries. First, the primary source of problems in the U.S. and European economies is embedded within the financial systems of these two regions. Specifically, the pricing bubble in real estate in both regions that was exacerbated by the profligate use of credit derivatives had little or no direct impact on the financial systems of the emerging countries. Secondly, at the outset of the financial crisis, many of the emerging economies were in much better fundamental shape than ever before. In fact, Brazilian government debt was rated as “investment grade” for the first time ever early in 2008. While the developed nations have been forced to bolster their individual economies through stimulus spending, many of the emerging economies have been able to avoid deficit spending and stimulated their economies through lowered interest rates alone.