In two speed world economy, one region provides two thirds of global growth

We inhabit a two-speed economic world – and the growth differential between buoyant East and depressed West is getting wider.

More than two thirds of all global growth this year and next is expected to come from the developing world. The main downgrades to growth are all in the developed world. Citibank recently slashed its forecast for growth in the US this year from 2.3% in July to 1.6%. Next year it expects growth in Europe of only 0.6% (versus 1.2% previously). By contrast, its reduction in the expected growth rate for emerging markets from 6.3% to 6.0% shows the extent to which they are increasingly able to stand on their own two feet.

The main worry in emerging markets – inflation and the prospect of higher interest rates – is likely to fade as the West flirts with a double-dip recession and commodity prices ease. The recent rate cut in Brazil was a straw in the wind pointing to an end of the tightening cycle in the developing world. With inflation still relatively high in many emerging markets, it might be too much to expect rates to start falling but even if they only tread water this would be a positive for markets.

The multiples of earnings on which emerging market shares trade are now – at about nine – back to the levels reached at the bottom of the 2000/03 bear market. They very briefly dipped lower in late 2008 but, that moment of panic aside, emerging market shares are cheaper on this measure than at any point in the past 10 years. They are also cheaper compared with the other main asset class, bonds, than they have been over the same period.

While shares have become cheaper, emerging market sovereign debt has become more expensive, dragged ever higher on the coat-tails of US Treasuries as investors have run for what they perceive to be safe havens.

For these three reasons, I think emerging market shares as a whole will outperform for the rest of this year and into 2012.

However, I don’t expect the indiscriminate sell-off to unwind in the same blind manner. Greater discrimination is already in evidence, with Korea for example a notable laggard as investors rightly took the view that its export-heavy economy would suffer more from a slow-down in the West.

If markets decouple, as underlying economies already have, the winners will be those companies exposed to rising domestic demand in emerging markets and not those dependent on a recovery in the West which remains a dim light at the end of the tunnel.