A Catalyst

With its strained upside action the market has shown it is tired and only in need of an excuse to stage a significant sell off. Today it has one. The emirate of Dubai has threatened to default on its debt.

On the face of it this is a fairly mundane matter, an extension of the commercial real estate difficulties we have seen emerge throughout the developed world. But this is The Emirates, an emerging market that is supposed to be an engine ready to lead the developed world out of its morass. That it could be a part of the morass cannot inspire confidence.

Dubai is unlike other emirates. It has no oil and has relied on debt, mountains of it, to transform itself. The emirate has been in difficulty for months and on Wednesday the government there stopped reassuring debt holders and instead asked them to accept delayed repayment.

The prospects of contagion cannot be dismissed. Neither can the prospect of a significant American equity market sell off.

Although we do not know with any certainty we can imagine the scenario that led to these events. The overarching Emirates government probably wants a claim to pieces of Dubai’s mortgaged jewel properties in order to make them whole and Dubai is likely refusing, thus leading to their demand for a debt holiday. Ultimately we believe that the Emirates government and Dubai in particular will resolve this matter with a solution that will be grudgingly accepted by creditors, as the prospect of outright default and the lack of confidence it would cause would be mostly absorbed locally.

But in the larger perspective the notion that emerging markets are the new engine that will drive worldwide recovery should take a well deserved hit. Chinese markets have been rattled recently by the government’s plans to reign in the centrally authorized lending that has been the conduit for their domestic stimulus. It has been this stimulus that has been a major source of worldwide market enthusiasm this year. When combined with Dubai’s debt crisis, those pushing domestic equity markets higher after their impressive run will be forced to think twice about exposure at these levels given the lack of growth domestically and the prospect of vulnerability in overseas markets that have heretofore been the raison d’etre for the rally.