Despite periods of market turbulence and investor retreat from risk, the emerging markets, as a group, have outperformed this year. The MSCI Emerging Market Equity Index, absolute return, US $, is up 6.6% year-to-date, September 13, whereas the MSCI World Equity Index is up only 0.7%. The developed-market ex-North America MSCI EAFE Equity Index is still down ytd by 1.2%. Looking forward, the emerging-market equity outperformance is likely to continue in the remaining months of this year and in 2011. There have been marked differences in performance among the various emerging-market national markets, and this too is likely to be a feature of the next 16 months. In this note we focus on the largest emerging markets, the so-called “BRICs” (Brazil, Russia, India, and China). In a second note we will comment on a number of the other emerging markets, including several we find to be particularly attractive despite their relatively small economies.
The macroeconomic fundamentals for the major emerging-market economies are very strong, and their strengths are mutually reinforcing through increasingly important trade flows. With fears of a double dip in advanced economies receding, global investors’ confidence in the future prospects for emerging markets is increasing. Debt levels are low and economic policies are, for the most part, sound. Inflation and speculative bubbles were a policy concern earlier in the year, but with monetary policy tightening, well-targeted efforts to reduce speculative pressures, and some currency appreciation, inflation appears to be peaking. Investors were concerned there could be a hard landing, particularly in China, but the latest data suggest the slowdown in growth apparent in the first half has moderated.
While the BRIC economies are the largest among the emerging markets and their economic growth rates are among the highest in the global economy, the +2.1% performance year-to-date of their equity markets, as measured by the MSCI BRIC Equity Index, has lagged that of the aggregate MSCI Emerging Market Equity Index cited above. Referring again to MSCI equity indices, India’s market did much better, a 10.2% gain, but China has advanced by only 1.1%. Brazil is still down by 0.9% ytd, while the Russian market’s gain is 2.8%. A comparison of the performance of these four markets over the past three months gives a different picture. China’s advance has caught up with that of India’s, 7.6% vs. 7.5%. Brazil has recovered dramatically, with a 17.0% total return over the past three months. Russia’s market also outperformed, with a 13.7% gain.
China, now the world’s second largest economy, sparked investor fears in the first half of the year that this locomotive of the global economy would slow sharply as Chinese policymakers sought to deflate a growing bubble in real estate and ease inflationary pressures. In the second quarter, data started to suggest the Chinese economy could indeed be easing dramatically. However, more recent data, particularly the data release of last weekend, with solid advances in industrial production (up 13.9% in August, yoy), retail sales (up 18.4% in August, yoy), and fixed-asset investment (up 24.8% in the January-August period, yoy), indicate the Chinese economy is back on track to register another 10+% growth this year. The data also revealed that fiscal stimulus has been increased in recent months, a fact not previously known to the market. Chinese equities are responding accordingly.
There is a growing number of ETFs that US-based investors can use to get exposure to the Chinese market. We will mention three worthy of consideration. Our preference for broad exposure to the Chinese market is the SPDR S&P China ETF, GXC. Its return over the past month was 3%. For investors willing to live with greater volatility, the Claymore/AlphaShares China Small Cap Index ET, HAO, advanced by 8.1% over the previous month. Finally, while its liquidity is close to the minimum we are willing to accept, the Global X China Consumer ETF, CHIQ, provides a way to get exposure to the very attractive Chinese consumer market. This ETF registered a 10% gain over the past month.
The Indian economy is growing at a close to 9% rate this year and, alongside China, is an important factor behind the strong growth in the Asia Pacific region. Inflation remains a concern to monetary authorities, with wholesale prices advancing at better than a 10% annual rate in the first half. The Indian central bank, the Reserve Bank of India, continued its process of normalization of interest rates this week by raising the repo rate by 25 basis points to 6% and lifting the reverse repo rate by 50 basis points to 5%.Industrial production advanced 13.8% in July, indicating a continuation of robust economic performance. We use the WisdomTree India Earnings Fund ETF, EPI, to access the Indian market. It is up 7.48% over the past month and 12% year-to-date. With strong economic growth, and end to the process of monetary tightening in sight, and equity valuations that are not especially high, the outlook for Indian equities is positive.
The Brazilian economy is rebounding from a slowdown earlier this year and is expected to advance by about 8% for the year as a whole, compared with a 0.2% drop in real GDP in 2009. Both industrial production and retail sales registered solid increases in July. Expansionary macro policies, which are expected to continue following the forthcoming elections, will continue to strengthen domestic demand, and exports will be driven by the recovery in global commodities. China has become Brazil’s biggest trading partner, surpassing the US. Moreover, China appears likely to be the biggest direct investor in Brazil this year, with investments in mining, steel, construction equipment, and electricity, according to the September 12 issue of The Economist. This growing relationship between the two emerging-market giants will be of global importance.
Brazilian equities fell sharply in January, and after a partial recovery swooned again in late April to early May, tracking but underperforming similar moves in overall emerging markets and global investor swings in risk appetite. The broad iShares MSCI Brazil Index Fund ETF, EWZ, has recovered since mid-May, up 4.0% during that past month, but is still down 5.0% ytd. The recovery is more dramatic in the Market Vectors Brazil Small-Cap ETF, BRF, which is up 13.0% over the past month and 10.2% ytd.
The forth BRIC, Russia, has an economy that that has recovered in the first half from a steep 7.9% decline in 2009. Manufacturing is advancing at a 15% clip. For the year 2010 as a whole, real GDP should be up by over 5%. Inflation is a concern here also, with a summer drought threatening a sharp increase in food prices. This could lead to monetary tightening by the central bank. Russian equities also have underperformed the emerging-market index, with the MSCI Russia Index registering a 2.8% advance year-to-date. The main ETF available for the Russian market is the Market Vectors Russia ETF, RSX, which is up 3.3% over the past month and 2.3% ytd. At Cumberland Advisors, while we see the improvements in the Russian economy, we continue to avoid Russia for our international and global portfolios, because other emerging markets offer a better investor environment with respect to corporate governance.