Related topics: stocks, emerging markets, interest rates, Brazil, Jim Jubak
You can circle this week on your calendar.
For the last six months, the world's emerging stock markets have been riskier than their developed market peers. For the next six months -- and perhaps longer -- the world's developed markets carry the greater risk. And in my opinion, you ought to start weighting your portfolio to reflect that shift.
Why assign the shift to this week in particular?
The interest rate increase from the European Central Bank today is not much -- just a move to a 1.25% benchmark rate from the historic low at 1% -- but it does mark the beginning of a cycle of interest rate increases in the big developed economies of the European Union, the United Kingdom and the United States. I think central banks in all three of these economies are about to embark on a cycle of interest rate increases that will stretch well into 2012.
The European Central Bank, the Bank of England and the U.S. Federal Reserve are all looking to slow rising inflation -- although with different degrees of urgency and different timetables. To fight inflation, the banks will raise interest rates, slow or reverse growth in money supply, and lower economic growth rates.
Jim Jubak
Slower growth, tighter money and higher interest rates have not historically been good for stock prices. At the least, they act as a drag on any potential rally.
Six months ago, it was the emerging economies of Brazil, China, India, Indonesia and Turkey that were at the beginning of a cycle of multiple interest rate increases, policy moves to restrict growth in money supply and lower growth rates. Those cycles of interest rate increases are not over, but in some countries I can see the end of the cycle within a quarter or two. And in some of these economies, the slowdown that these policies were intended to produce has already visibly taken hold.
Stocks in these markets could still move somewhat lower in the near term as expectations for growth move from reasonable to extreme pessimism. But the end of the downward pressures is in sight.
A tale of 2 markets
Contrast these two sets of markets, emerging and developed, using Brazil and the European Union as examples.
In Brazil, the Banco Central do Brasil has aggressively raised interest rates to 11.75% starting in April 2010. The economy has started to slow even though inflation has continued to climb.
But the financial markets are pricing in an end to a cycle of interest rate increases that began with the benchmark Selic rate at 8.75%. Expectations are now that the central bank will raise the benchmark again in April, but that the top to this cycle -- 12.5% -- isn't so far away. Inflation will peak at 6.5% in the third quarter, the consensus now holds, and then gradually pull back to the central bank's target of 4.5% in 2012.
In other words, at some point not too far down the road, investors will be able to start anticipating not just an end of increases in interest rates, but below-target inflation, potential interest rate cuts, and rising economic growth as well.
Europe doesn't look so rosy
Contrast that with the situation in the European Union after today's interest rate increase. The financial markets now project that the central bank will raise rates three times in 2011 in small 0.25 percentage point increments.
But that doesn't mean the cycle will include just those three interest rate increases. In March, inflation climbed to a two-year high of 2.6% -- well above the bank's target of close to, but not above, 2%. Unlike the U.S. Federal Reserve, the European Central Bank includes food and fuel costs in its inflation measures, and with prices in both those sectors climbing, getting inflation under control won't be easy.
