FALL 2009
(Q3-2009 Data)
Volume 19, Number 4

merging markets equities rose 21.0% during the quarter and are now up 64.9% year to date, far outpacing developed market indices. Newgate’s Portfolio gained 19.7% for the quarter and is up 52.5% year to date. Emerging markets now have positive annualized performance for trailing 1, 3 and 5 years; neither the S&P 500 nor MSCI EAFE Indices can make that claim.

Market Review. The recovery in emerging markets has been powered by two factors. First, valuations troughed at the depths of the credit crisis; simply not falling into the economic abyss accounts for some of the recent market rebound. The second factor is the real economic strength of many emerging markets. This new power of emerging markets was clearly evident during the G20 summit in Pittsburgh, when it was announced that the G20 would replace the G8 as the world’s primary economic forum. This group not only includes large emerging markets such as China, Russia, and Brazil, but also smaller ones like Turkey, South Africa and Saudi Arabia.

China remains key to emerging markets. Despite naysayers, the government stimulus package has succeeded in maintaining strong economic growth. Chinese equities, however, lagged the MSCI Emerging benchmark, returning just 7.8% during the quarter. Unlike other emerging economies, China’s heavily managed currency does not allow equities to benefit from a declining US dollar.

Strong Chinese domestic demand fueled most Asian markets, such as Korea which rallied 35.5%. Trade with China has led to a rapid recovery in industrial production, exports and GDP. Korean car companies and related industries also benefited from the US “Cash for Clunkers” program, a source of stimulus that has since been removed. Taiwan, another beneficiary of China’s growth, is a highly bifurcated market. Technology companies are doing well as global demand for handheld devices has been surprisingly strong, but domestic companies are lagging. Better relations with the Mainland have boosted equity prices but will not impact the profitability of Taiwanese companies until well into the future, resulting in an expensive market.

Brazilian stocks were up 27.4% and have now doubled year to date. Despite this strong performance, Brazilian equities are trading at only 14 times current earnings, just slightly above their longer term averages. In October 2010, Brazil will have an election to replace President Luiz Inacio Lula da Silva, who is constitutionally barred from a third term. Brazil’s strongly independent central bank succeeded in mitigating the global financial crisis. However, the head of the central bank may leave his post in April 2010 to run for governor. Even though Brazil is a model for development of emerging markets, there is the potential for significant change during the next 12 months and thus heightened market and political volatility.

Russian equities gained 27% and are now up 84.9% for the year. Russia is the epitome of a commodity based economy, with over 75% of the country’s market capitalization in energy and materials. Eastern Europe generally outperformed the rest of emerging markets, with Poland up 33.9% and Hungary up 42%. This strong rebound is not surprising, given that these three countries were among the worst performing during the credit crisis. All three still have negative performance over the past 12 months.

Portfolio Review. Allocations to China were reduced slightly during the quarter, though the country remains our largest position relative to the Index. We believe that investors are now beginning to understand that the economy is increasingly domestic, rather than export driven. With the Chinese economy reaccelerating, we have added to Korea and Brazil and are moderately overweight both these markets, with 15% and 17% allocations, respectively. We increased India slightly, but our 5% position is still underweight that market. Indonesia, one of the best performing markets, was eliminated. Indonesia, Korea and Russia were the greatest contributors to performance during the quarter. China was one of the largest detractors relative to the index, though most investments were profitable.

Outlook. The Portfolio has been concentrated in those countries with the strongest macroeconomic positions. This has proven beneficial not only during the past credit crisis, but also as the global economy recovers. Valuations in emerging markets are reasonable considering the low interest rate environment and the growth premium of emerging markets relative to developed countries. Last year’s crisis has forced investors to reconsider outdated notions regarding global asset allocation, to the benefit of dedicated emerging market investments.