Volume 19, Number 3
merging markets equities rose 34.8% during
the second quarter as global investors snapped
up shares at a record pace. Year to date, the
MSCI EM Index has gained 36.2%, significantly
outpacing the MSCI All World and all other developed
markets indexes. Newgate’s Portfolio gained 27.2%
during the quarter and up 27.5% year to date.
Market Review. The total value of emerging
market equities reached an all time high relative to
the global markets by the end of the second quarter.
Collectively, emerging markets now comprise 24%
of global market capitalization, up from 18% at the
beginning of the year.
Since there has been very little IPO activity this
year, relative outperformance of emerging markets has
been the primary driver of this increase in market share.
This outperformance, combined with attractive valuations
and growth prospects, spurred over $26 billion in fund
flows into emerging market equities during the quarter. Overall, emerging market economies are relatively
healthier than most of the developed markets. Forecasts
of a major recession in China have proven false, and
the Chinese economy is reaccelerating. Economies
from Brazil to South Korea and Indonesia also appear
to be heading out of recession.
The US dollar is also a significant factor in
emerging market psychology. Developed market central
banks have cut interest rates to essentially zero and
have engaged in some form of quantitative easing. Any
single country instituting these policies would see its currency
weaken. But when all developed nations do it, the
results are unclear. Since emerging market countries
have stabilized interest rates, their currencies have
generally appreciated against all those in the developed
markets. Emerging markets (equities, debt and currencies)
have become a hedge against US dollar weakness,
and are likely to remain so even if the dollar rises
against other developed market currencies.
Every emerging market had positive returns
during the quarter. In Asia, India had the best performance,
up 60%. May elections resulted in a strong
coalition dominated by the Congress Party and its allies
and reduced participation by the far left. It is expected
that this realignment in government will allow the
implementation of much needed economic and political
reforms. Chinese equities gained 36% as the economy
continued to expand at a better than expected pace.
Korean equities rose 25% despite increased tensions
with North Korea. The Korean won, which declined
dramatically last year, rose almost 10% during the quarter
on rising interest rate expectations.
In Latin America, Brazil rose 41%, bolstered
by higher commodity prices. Mexico, that had been
lagging due to its strong economic ties to the US, rose
36% during the quarter. At the end of May, Argentina
was removed from the MSCI Emerging Market Index
due to capital restrictions imposed by the Fernandez de
Eastern Europe also experienced a rebound
during the quarter. Russia rose 38%, aided by a stronger
ruble and higher energy prices. Poland, hit hard by the
global credit crunch, was up 37%, though it remains
the only country with negative returns year to date.
Smaller countries tended to do well in all regions.
Indonesia, Colombia, Thailand and Turkey each rose
more than 50%. It is not unusual for markets with less
depth and liquidity to have extreme swings in price,
both positive and negative.
Portfolio Review. China remains one of
the dominant themes in the Portfolio. Not only is the
economy one of the most vibrant in our universe, but
it continues to have a significant positive impact across
most of its key trading partners. We ended the quarter
with a 26% allocation to the country, modestly reduced
by profit taking in Hong Kong. China was also the
single largest contributor to last quarter’s returns,
followed closely by Brazil. We remain underallocated
to Taiwan and India. Although the recent political
developments are promising, valuations in those
markets are not compelling enough and we are looking
for more attractive entry points.
Outlook. The Portfolio is invested in larger
capitalization stocks that offer a higher degree of safety
warranted in the current economic climate. While
globally things are better, and better than the worst
case expectations so commonly forecast, there are still
risks to the global economy. Most emerging markets
seem clearly in a superior position, with less debt and a
simpler financial structure. At 13x earnings, valuations in
emerging markets are still attractive, but are approaching
historically average levels. What is not average is the
growth rate differential between the developed and
developing world, which should continue to attract
capital into emerging market economies and reward
investors with favorable returns.