"It's a zero sum game, after all"

Any shards of residual decoupling theories have been laid to rest by the draining more than $2 billion out of emerging-market funds in each of the past two weeks. The surprise, perhaps, is that emerging markets have not performed even more poorly; the MSCI emerging-markets index’s 12.4% decline so far this year is only a little worse than the return of the global market. Amongst the central bankers of the emerging markets, RBI has been the latest, raising interest rates for the second time in a month on June 24th, even though higher rates will mean slower economic growth. But central banks will be damned either way. Any country that fails to raise rates enough to keep inflation under control will scare away investors. South Africa and Vietnam have failed to keep the lid on prices and have been duly punished with a depreciating currency.

So how did the decoupling theory fail and emerging markets suddenly lose their charm?

One look at the MSCI index – that foreign investors’ favorite benchmark – gives some idea. Emerging markets benefit from the heavy weighting of commodity-related stocks in the index (more than a third, according to Merrill Lynch). The overall market is unlikely to plummet when mining and energy stocks are holding up so well. The corollary, however, is that emerging markets will be vulnerable if commodity prices tumble. Earlier in this decade, conditions were ideal for emerging markets, because commodity prices were going up and local interest rates were going down. Now interest rates are rising and there is the risk that commodity prices could at some point correct.

It’s a zero sum game after all.