Emerging-market stocks are slumping into the New Year as food and energy inflation hit hard, especially in frothy Southeast Asia.

India’s benchmark has fallen 6.2 percent. Indonesian share are down about 7 percent. Philippine stocks are off 4 percent and riots erupted in Bangladesh after stocks there fell sharply, now down 20 percent for the year, reports The Wall Street Journal.

In comparison, the S&P 500 Index, while volatile, has put on 2 percent since the year began. The Dow Jones Industrial Average is up about 1.5 percent.

Volatility isn't surprising in emerging markets, and some of the factors at play here are the same as 20 years ago, when foreign stocks first caught the attention of deep-pocketed global investors.

"Hot” money-flows in and out of smaller-country exchanges have prompted capital-control regimes in Chile and Malaysia in the past. Brazil recently instituted a tax on certain foreign investments to slow the movement of speculative money and protect the real from appreciating too quickly, which hurts its export economy.

One major factor, however, is new: Massive dollar printing by the United States — the vaunted quantitative easing promoted by the Federal Reserve — is pushing inflation higher in poor countries. The only real defense small countries have against a rising tide of wandering dollars is to raise domestic interest rates in hopes of slowing growth.

Fear of higher rates is thus prompting the stock sell-off.

"You can't have erosion of purchasing power and hope growth will remain. The two are pretty inconsistent," Sanjay Mathur, an economist for Royal Bank of Scotland in Singapore, told the Journal. Indian wholesale inflation hit 18.3 percent in late December, according to the newspaper.

Part of the reason for investor flight, too, is that emerging stocks have ridden so high, so fast, as U.S. dollars seek a return. Irked by low Treasury yields and volatility at home, American and European investors have pushed billions into tiny stock markets across the Far East.

Fed officials have given conflicting signals about the future of the easing program, scheduled to total up to $600 billion (and possibly as much $900 billion) through June.

The easy ride may be over for now, but it begs the question: Where does all the investor cash head next?

Europe is on the ropes, which normally would be inviting to investors seeking beaten-down stocks. But the question marks over the euro there might be one too many.

Harvard University economist Niall Ferguson says that the danger of a total bust-up of the eurozone is all too real. The monetary union’s rescue facility of $973 billion isn’t enough to save the latest basket case, Portugal, while Greece and Ireland are still hobbled, Ferguson noted.

“Without some kind of much bigger step in the direction of fiscal federalism, we just get one expedient after another and it’s never enough,” Ferguson told Bloomberg Television in an interview. “In that case, a disintegration becomes a real possibility.”

In a separate interview, Nobel Prize-winning economist Christopher Pissarides said that a collapse in Spain, one of the eurozone’s larger economies, would spell the end of what has been so far the only serious paper alternative to the U.S. dollar.

“If Spain collapses the way Greece has collapsed I don’t think the European Union has the resources to rescue it,” Pissarides told Bloomberg News.

Meanwhile, despite massive tax increases in Illinois and unheard-of budget cutting on the table in California, no clear path for reducing the U.S. federal deficit has surfaced since the Obama deficit commission failed to bring its plan to Congress before Christmas.

Despite it all, U.S. investment banks, with few exceptions, see a bull run continuing at home and tame U.S. inflation.

“We see a number of potential risks for the economy and the markets in the year ahead, including sovereign-debt issues, emerging-markets inflation and the possibility of higher tax rates, but we remain positive on the overall environment. Inflation should remain low throughout 2011,” says Bob Doll, chief equity strategist at money-management firm BlackRock, in a note to investors.

U.S. indicators have continued to improve, suggesting that unemployment could finally turn around, says Jim O’Neill, chairman of Goldman Sachs Asset Management.

“It will remain in 2011 a long way from where it ideally should be, but at least it will now be moving in the right direction. A number of quarters of 3 percent to 4 percent or more real GDP growth are likely in the next couple of years,” O’Neill wrote in the Financial Times.

For investors, that outcome would mean “modest” inflation at home, a decline for government bonds, a resurgent dollar, at least against other paper currencies (except probably China’s yuan) and, O’Neill predicts, “another powerful leg of the global equity-market rally that commenced in spring 2009.”


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