Which Way Emerging-Market Equities?

By: Prieur du Plessis | Tue, Mar 23, 2010
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With investors' risk appetite emboldened by the prospects of an economic recovery, emerging-market equities (+104.0%) have outperformed mature-market equities (+73.3%) by a considerable margin since the commencement of the cyclical bull market in early March 2009. But these numbers camouflage the fact that the past six months have been characterized by essentially a sideways movement in relative performance. This raises the question as to how investors should place their bets over the next few months.

Emerging-market equity prices as measured by the MSCI Emerging Markets Free Index are primarily driven by commodity prices and in particular by metal prices, as seen from the comparison of the MSCI Emerging Markets Free Index with the Economist Metals Price Index in the graph below. In short, emerging-market stocks are currently fairly priced given the level of metal prices.

Economist Metals Index and MSCI Emerging Market Free Index - 8-year
Source: Plexus Asset Management (based on data from I-Net Bridge).

However, the outlook for emerging-market equities is less positive given the cloudy outlook for metal prices owing to China's credit tightening, and high stock levels of some metals at the London Metal Exchange (LME). Improved global industrial production and stronger economic growth in especially developed economies are likely to underscore metal prices and therefore emerging-market equities, though.

The relative performance of emerging markets versus mature markets, as measured by the ratio of the MSCI Emerging Market Free Index and MSCI Global Index, is also driven by commodity prices and specifically metal prices. The relative risk of investing in emerging-market equities has increased as the ratio has surged ahead of metal prices. At best, the MSCI Emerging Market Index could maintain the current relative levels against the MSCI Global Index should metal prices move sideways. But metal prices heading lower could lead to significant underperformance by emerging markets compared to mature markets.

Economist Metals Index and MSCI Emerging Markets Relative to MSCI World - 3-year chart
Source: Plexus Asset Management (based on data from I-Net Bridge).

As shown, metal prices need to rise substantially to ensure further outperformance by the MSCI Emerging Markets Free Index.

Economist Metals Index and MSCI Emerging Markets Relative to MSCI World - 8-year chart
Source: Plexus Asset Management (based on data from I-Net Bridge).

With the commodities benchmark Thomson Reuters/Jefferies CRB Index again having fallen to below its 50-day moving average, it looks as if traders' short-term appetite for commodities is waning. Based on the analysis above, the same could hold true for emerging-market equities, especially with the Shanghai Composite Index - the big gorilla in the group - battling to climb back to above its 50-day line and now also trading 13 points below the key 200-day average.

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Prieur du Plessis

Author: Prieur du Plessis

Dr Prieur du Plessis
investmentpostcards.com

Dr Prieur du Plessis

With 25 years' experience in investment research and portfolio management, Dr Prieur du Plessis is one of the most experienced and well-known investment professionals in South Africa. More than 1 000 of his articles on investment-related topics have been published in various regular newspaper, journal and Internet columns. He also published a book, Financial Basics: Investment, in 2002.

He holds the following degrees: BSc (Quantity Surveying) (Cape Town), HonsB (B & A) (cum laude) (Stellenbosch), MBA (cum laude) (Stellenbosch); and DBA (Doctor of Financial Management) (Stellenbosch).

Prieur is chairman of the Plexus group of companies, which he founded in 1995. Previously he was general manager: portfolio management at Sanlam, responsible for the management of investment portfolios with total assets in excess of $5 billion.

Plexus is a pioneer in the mutual fund industry and has achieved a number of firsts under Prieur's leadership. These include the authoritative Plexus Survey, a quarterly analysis of the consistency of the performance of unit trust management companies, the Plexus Offshore Survey, the Plexus Unit Trust Indices, and the PlexCrown Fund Ratings.

Plexus is the South African partner of John Mauldin, American author of the most widely distributed investment newsletter in the world, and also has an exclusive licensing agreement with California-based Research Affiliates for managing and distributing its enhanced Fundamental Index™ methodology in the Pan-African area.

In 2001 Prieur received the Santam/AHI Business Leader of the Year award for corporate leadership, business acumen and entrepreneurial flair. He was also profiled in the book South Africa's Leading Managers (2006). Plexus received the AHI/Old Mutual Enterprise of the Year award in 1997 and was also included in the book South Africa's Most Promising Companies (2005).

Prieur is 52 years old and lives with his wife, TV producer and presenter Isabel Verwey, and two children in Welgemoed, Cape Town. His recreational activities include long-distance running, motor cycling and reading. He belongs to the Cape Town Club, Johannesburg Country Club, Gordon's Bay Yacht Club and Swiss Social & Sports Club.

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