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MSCI’s developed market stock index up 3.2%, emerging market index is negative
Reuters
29 January 2011
A month into 2011, one of the biggest swings in asset flows has been the outperformance of previously lagging developed market equities against once red-hot emerging ones.
The chances are that this rotation by investors, encouraged by shifting valuations, inflation concerns and growth spurts in some developed economies, will remain in place for a while - perhaps six months - but it is not likely to become a permanent fixture.
Nothing has happened to dilute the overarching view that emerging markets are a long-term, strategic growth story, albeit with somewhat heightened political risk - as is now being seen in Egypt and Ivory Coast.
Standard & Poor’s cutting of Japan’s sovereign debt rating on Thursday, meanwhile, was a stark reminder that, in contrast to emerging economies, many developed markets continue to suffer from government bank balance problems.
But for the time being, the tale of the tape is clear - the flows are into developed markets and away from emerging.
So far this year, MSCI’s developed market stock index has risen a healthy 3.2 per cent - healthy in the sense that in the highly unlikely event that this rate continues, developed market stocks would have the best compounded gain in at least 40 years.
The benchmark emerging market index, however, is in negative territory, having fallen more than three-quarters of a per cent.
Individual country indexes show the same pattern. The US S&P 500 is up more than 3 per cent for the year while India’s Sensex has lost around 10 per cent.
The outperformance goes further. On a day-by-day basis last year, developed markets outperformed emerging markets on just 47 per cent of occasions. So far this year, they have done so around 63 per cent of the time.
And in terms of beta, a gauge of how a security reacts to moves in the market, emerging markets are moving closer to being in lockstep with developed markets - meaning that at the moment, there is little to be gained for the extra risk that they may carry.
Emerging market beta is currently close to 1.0, compared with 1.8 about five years ago.
Three things have brought this about, and the issue for investors is how long each will remain a driver.
First, the popularity of emerging markets has made them a very crowded trade, meaning that prices have arguably got ahead of themselves.
‘They had a good run over the past couple of years and the valuations are now looking more full,’ said Jason Hepner, investment director at Standard Life Investments.
Second, as a result of their recent growth, many emerging markets are coming up against strong inflationary headwinds which are prompting central banks to enter a tightening cycle.
Food price inflation, a growing issue, is likely to have more impact on emerging markets than on developed ones.
Credit Suisse estimates that food represents about 34 per cent of an Asia ex-Japan consumer price basket. In the US, it accounts for less than half that.
Thirdly, some leading developed economics, particularly the US and Germany, are showing strength.
Fund flow analysts EPFR Global say that the week up to Jan 21 was the sixth of net inflows to US equity funds that they track out of the past seven, amounting to total net inflows of US$17.3 billion.
It compares with net US$49 billion outflows from the sector in 2010.
So will it last? The indications are that it won’t and that most of the embrace of developed markets has been tactical, a short-term move to grab an opportunity.
Goldman Sachs, for example, has been telling its clients to emphasise US and Japanese stocks in the first half of the year and to go back to emerging markets (EM), along with European markets, in the second half.
There is also a likelihood that some of the factors putting investors off emerging markets at the moment will reverse.
William De Vijlder, chief investment officer at BNP Paribas Investment Partners, reckoned that inflation pressures will ease in emerging markets along with uncertainty about monetary policy, in part because there is little evidence of China overheating.