SPRING 2010
(Q1-2010 Data)
Volume 20, Number 2

ewgate’s Emerging Markets Portfolio rose 1.7% during the first quarter, maintaining the momentum of last year’s 60.6% gain.

Market Review. The global economic recovery that began in emerging markets has spread to the developed world, especially the United States. Most emerging economies experienced a slowdown, but few technically fell into recession. Many emerging markets have either started to raise interest rates (India and Israel) or like Brazil, are expected to shortly.

China remains the most important and unpredictable variable in the global macroeconomic equation. It has had tremendous growth in “fixed asset investment” – essentially real estate, transportation and similar projects, funded by a loose monetary policy from the central bank. It is well acknowledged that the Chinese government needs to reduce lending and tighten monetary policy, regardless of how this policy change is implemented.

Some market commentators suggest that the entire Chinese economic rebound is attributed to government policies, and that there is now a bubble. We do not agree with that assessment. China is a large country in geography and population. Unlike Dubai (to which China has been compared), it does not require a large influx of foreigners to purchase property or set up businesses. It does require harnessing its own people to consume more domestically produced, higher value added goods, rather than simply produce lower quality goods for exports. To this end, China’s spending on fixed asset investment is just that, an investment; the determination of final return is years if not decades away. Those pessimistic on China’s future assume that there will be no return, either in increased productivity or domestic consumption, from its building spree. We take the view that this spending is necessary for China to develop from its current status of a largely rural, agrarian and poor country.

Changes in monetary policy and fear regarding bad loans have resulted in Chinese equities underperforming other large emerging markets last year and again this quarter, losing 1.6%. Newgate has maintained approximately a 25% allocation to China. Its recent underperformance has left many stocks, including several of the largest and most liquid, attractive against a universe that is otherwise fairly valued. We believe any change in policy is largely priced into the market.

Taiwanese equities declined 3.8% during the quarter. Technology stocks dominate that market and had strong performance last year. India and Korea rose 4.9% and 4%, respectively. The shift in exports from the US to China in the past 12 months benefited all countries, even India, whose exports to China consist largely of raw materials and chemicals. Reacting to double digit inflation, the Indian Central Bank surprised the markets with a 25 basis point intermeeting rate hike, with further increases expected at their April meeting. Forecasts are for Korea and Taiwan to raise rates by the third quarter.

Portfolio Review. Brazilian stocks were unchanged in the quarter. We added to positions there, increasing the allocation to over 19% as we believe that markets have fully factored in expectations of a rate hike to reduce the country’s 7% inflation rate. Although the Brazilian economy is associated with commodities, its domestic economy is also thriving. Unemployment is at a record low 7.1%, even though the labor force is increasing. In other words, more Brazilians are seeking and finding work, a sharp contrast to the developed world, where many discouraged workers are no longer seeking employment. Mexican equities had strong performance, up 7.8%. Mexican exports to the US, especially cars, have accelerated sharply with the US economic rebound. Mexico represents 4% of the Portfolio.

The Russian equity market rose 6.8%, buoyed by oil prices gaining over 5% during the quarter. While investors distrust the Russian government, Russia’s access to oil, gas, copper and its large, integrated steel manufacturing companies make investments in the country unwise to disregard.

Outlook. Global investors are increasing their strategic allocation to emerging markets. We do not believe this is a fad, nor is it chasing performance. Rather, it is an acknowledgement that the expectations for growth and development are much greater for emerging economies relative to developed ones. Equally important, the concept of sovereign risk is now widely discussed, not only regarding Greece, but also the UK, Japan and even the United States. This shift in investor viewpoint puts emerging markets on more equal footing with developed ones with respect to asset allocation decisions.