Tuesday, February 7, 2012

Emerging Markets Update


The Financial Times has two articles this morning discussing the sudden investor appetite for stocks and bonds from the emerging markets.

The chart to the left of this piece visually illustrates what happens when investor sentiment changes from "risk off" to "risk on" in the emerging markets.

What I am showing here is the price action of the Vanguard exchange-traded fund (ETF) that invests in stocks emerging market countries like Brazil; South Korea; China; Taiwan; and South Africa.  The ticker for the funds is VWO.

 As you can see, the last couple of years have been quite a ride for investors, with VWO trading a 40% wide trading range.

More recently, from the lows reached last October, VWO is up nearly +18% through yesterday  Still, VWO is trading 14% below where it was in April 2011, and 25% lower than the all-time highs in October 2007.

VWO is currently trading at less than 10x estimated earnings for 2012, which makes it one of the cheaper sectors of the global stock markets.

Hence the investor interest.

Here's what the Financial Times wrote:

Money has poured into emerging markets this year, with funds dedicated to the asset class enjoying their best start to a year since 2006 amid continued investor wariness over developed markets.

Emerging market equity funds, which fell out of favor for much of last year, attracted $3.5bn in the week ending February 1, the most in almost a year, taking the total inflows this year to $11.3bn, according to EPFR Global, a data provider.

Emerging market bond funds saw inflows of $1.2 bn last week, the most since March last year. Buoyed by the renewed surge in capital inflows, emerging market currencies have also enjoyed a strong start to the year.


The FT also has a second piece titled "Brazilian Equities Burst Back Into Life in Global Rally".  The article notes that both the Brazilian stock market and economy are showing signs of a very strong rebound from the lethargy they had settled in last fall.

Both articles, of course, quote the usual cautionary commentary from global strategists, noting that markets that show such strong short term moves are often vulnerable to corrections.

This is true, of course, and price action in the emerging market bourses are usually more volatile than in the developed markets.

But still I think that 2012 could shape up well for the emerging markets for  a couple of reasons besides valuation.

First, the currencies of most emerging market countries can be much more readily controlled by government action than the more developed nations.  Last year, for example, both Brazil and China were aggressively tightening monetary policy to try to contain inflationary pressures.  The medicine worked:  their economies slowed significantly by late summer.  Now, however, both countries are trying to revive economic activity, and I suspect they will be successful.
Second, commodity prices play a much greater role in the daily lives of the citizens of the emerging economies. Ned Davis Research indicates that nearly 50% of the discretionary income of consumers are devoted to food and fuel costs, as opposed to only 15% in the developed nations.  With most commodity prices significantly lower than a year ago, there should be more money available to go into other parts of their respective economies.