Normally, the first half of pre-election years is good for equities. The logic is this, in the pre-election year, government tend to expand public credit because this is when the majority of economic policies are put into effect. As long as government credit expansion succeeds private credit contraction, asset price appreciates.
However, chances are these governments driven policies (cheap credit) causing economy overheating and pushing interest rate higher. Had private credit contraction succeeded government credit expansion, market crashes.
When we entering the second half of year 3, given today’s equity markets’ highly correlation, high volatility and downside risks for emerging markets are anticipated.
Hedge fund manager Jeremy Grantham wrote in his Q1 2011 letter:
To make money in emerging markets from this point, animal spirits have to stay strong and not much can go wrong. This is possibly the last chapter in a 12-year love affair…from now on, we must be more careful.
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| Shanghai Composite Presidential Cycle |
As far as I’m concerned, if we encounter say any type of weather disruption which triggers soaring food prices, or 1970s style oil embargo in Arab world, emerging market would be brought down to stagnation immediately. With today’s euphoria about emerging markets, this one tail risk should be bet against.
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