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Market Commentary: More Emerging Markets Outperformance?
March 15, 2010
As investor sentiment continues to recover, it is emerging market stocks (helped by currency appreciation and led in local currency terms by Latin America and emerging Asia) that have taken the lead among global equity markets. And even in the face of administrative measures designed to slow bank lending, the Chinese market has led the rally within emerging Asia, in line with our view that China's efforts to prevent its economy from overheating are likely to extend rather than impede its recovery.
Separately, in what was a relatively light week of new economic data in the developed economies, the wealth of Chinese releases for the month of February raised few alarm bells. Bank loans rose by some ¥700 billion, well down on the prior month, but still not far from the average monthly increase in 2009, while year-on-year measures of broad money growth slowed only marginally: M1 grew at 35.0% and M2 at 25.5%. And notwithstanding the still rapid expansion in credit, the ongoing rise in CPI inflation (which saw its biggest monthly increase in almost two years) remains principally driven by food prices. Indeed, non-food consumer prices actually fell on the month, recording only a mild 0.6% year-on-year increase. Retail sales accelerated, growing at 22.1% over a year ago, while growth in fixed asset investment (which includes government infrastructure spending as well as private investment) also remained robust.
But perhaps most importantly for global markets, Chinese exports recorded stronger than expected growth in February, with the 45.7% year-on-year increase (4.8% for the month) taking the level of export activity back above the pre-crisis peak of August 2008. A sustained recovery in exports is a condition that will almost certainly have to be met before China begins to loosen the renminbi's peg with the U.S. dollar and allows the currency to appreciate. And despite recent political rhetoric, the case for a stronger renminbi may have been reinforced by the recent rise in other emerging Asia currencies, which have appreciated by more than 10% against the U.S. dollar over the past 12 months, and are up against all but the commodity currencies and the Japanese yen so far this year. Furthermore, recent comments from the governor of the People's Bank of China, stating that the mid-2008 re-pegging was part of a "package of policies for dealing with the global financial crisis" that would be removed "sooner or later", may hint at some degree of revaluation in the relatively near term, potentially ahead of the U.S.-China 'Strategic Economic Dialogue' in early May.
The prospect of a stronger Chinese currency, which would likely be accompanied by further appreciation in other Asian currencies, does not weaken our preference for emerging Asian equities (and therefore emerging markets overall); it should help to both dampen inflation and support local profitability by reducing the cost of imported raw materials. Indeed historically, emerging Asian markets have outperformed global equities (even in local terms) when their currencies have been appreciating (see chart).
And while there may be some additional upward pressure on U.S. bond yields if China slows its pace of Treasury accumulation as it relaxes its currency peg, we would not expect any undue disruption in the Treasury market due to the deleveraging U.S. consumer and increased household saving. Flow of funds data released by the Federal Reserve last week showed that U.S. household sector Treasury holdings increased by some $531.3 billion in 2009, dwarfing the $167.4 billion increase in Chinese holdings reported by the Treasury over the same period.
The massive outperformance of emerging market equities in 2009 has moderated in recent months, but it remains our view that the stronger fundamentals (including lower public and private sector debt levels, healthier banking sectors, and faster growth rates) should make for better long term performance in EM, while nearer term factors also appear supportive. Figures from EPFR global (a financial market data provider), show that global emerging market funds have recorded net inflows of some $1.8 billion so far this year, in contrast with net outflows posted by developed market funds. And even after the significant outperformance of the past year, emerging market valuations are still over 10% below their price/earnings valuation peaks of late 2007 relative to developed market equities. Thus in our view, while it may have unsettled markets earlier in the year, gradual rather than aggressive Chinese policy tightening (even if it ultimately includes currency revaluation) need not necessarily be an impediment to further emerging market outperformance.
-- Stu Schweitzer & Ehiwario Efeyini, Global Markets Strategists
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