There are two things that drive equity markets. One is earnings and the second is liquidity. We know that during recession earnings fall. At this point it is liquidity created from money printing that drives the markets. But once that liquidity dries up, prices revert to their fundamental value supported by earnings. Something similar has been happening in the emerging market countries like Indonesia, Thailand and Philippines. Until recently, these markets were soaring. This was due to the liquidity injection exercise undertaken by US Federal Reserve. However, Ben Bernanke has now given indications that this stimulation exercise may come to an end soon. As such, these emerging market stocks have taken a beating.

It is not that these markets were supported just by the external liquidity. The fundamentals of these markets were strong enough to attract foreign capital. But in emerging markets, not enough savings are channelized into equities. Thus, they are more dependent upon external cash flows. And this external cash flow depends upon the monetary policy exercise of ECB or Federal Reserve. Unless enough domestic savings are channelized into markets, emerging equities will continue to remain dependent upon foreign capital. And thus remain volatile to that extent.