Emerging Market Equity
After rallying for 3 1/2 months with barely a correction along the way, emerging market equities have corrected since January 3rd. Even with the rally of the last couple of days, most emerging markets are well off their highs.
We've noted in the past that many emerging markets have a high correlation to commodity prices, which have tumbled over the past several months. But why the delayed reaction by emerging markets? According to Justin Lahart in today's WSJ, "one possibility is that the emerging-market selloff was simply a delayed reaction to what happened in December. The rally in emerging-markets stocks - the emerging-markets index rose 29.2% last year - may have prompted some investors to delay selling until this year in order to avoid a big tax hit. At the same time, some fund managers may have been pouring money into emerging-market stocks in the last part of the year in a bid to improve their 2006 performance. Once the New Year started, that bid went away."
Sounds reasonable to us. Justin's follow-on reason is that as a result of December's strong jobs reports, investors are now projecting a rise in interest rates rather than a fall, and as such, emerging market selling reflected a "worry that monetary policy . . . was getting overly tight." This reason is too large of a reach. Money supply has actually trended strongly up recently - not down, even though fed funds rates remain unchanged.
While it is true emerging-markets are not as commodity sensitive as they once were (partially because of their large trade surplus' built up over the last decade), commodity price correlation remains strong. We believe any meaningful decline in emerging markets should be bought. Consider that the USA uses 25.0 barrels/year of oil per capita. Japan is at 15.0 and Mexico at 7.0. Yet Latin America uses 4.5 and China 1.7 barrels (source: The Economist). Per capita usage of Copper in lbs./annum is 4.7 in China versus 15.8 in the USA; Aluminum is 4.0 for China versus 21.0 in the USA; and Autos per 1000 people are 6.0 in China versus 475 in the USA. This lull in the economy has produced a narrow surplus in oil production versus demand. Yet per capita commodity consumption demonstrates that developing market demand is still at an early industrialization stage. If some economists are right that we've turned the corner on the housing slump, contributing to improved world GDP in 2007, it is unlikely that commodities will experience much of a decline from these levels. This bodes well for commodities and emerging markets.
We've noted in the past that many emerging markets have a high correlation to commodity prices, which have tumbled over the past several months. But why the delayed reaction by emerging markets? According to Justin Lahart in today's WSJ, "one possibility is that the emerging-market selloff was simply a delayed reaction to what happened in December. The rally in emerging-markets stocks - the emerging-markets index rose 29.2% last year - may have prompted some investors to delay selling until this year in order to avoid a big tax hit. At the same time, some fund managers may have been pouring money into emerging-market stocks in the last part of the year in a bid to improve their 2006 performance. Once the New Year started, that bid went away."
Sounds reasonable to us. Justin's follow-on reason is that as a result of December's strong jobs reports, investors are now projecting a rise in interest rates rather than a fall, and as such, emerging market selling reflected a "worry that monetary policy . . . was getting overly tight." This reason is too large of a reach. Money supply has actually trended strongly up recently - not down, even though fed funds rates remain unchanged.
While it is true emerging-markets are not as commodity sensitive as they once were (partially because of their large trade surplus' built up over the last decade), commodity price correlation remains strong. We believe any meaningful decline in emerging markets should be bought. Consider that the USA uses 25.0 barrels/year of oil per capita. Japan is at 15.0 and Mexico at 7.0. Yet Latin America uses 4.5 and China 1.7 barrels (source: The Economist). Per capita usage of Copper in lbs./annum is 4.7 in China versus 15.8 in the USA; Aluminum is 4.0 for China versus 21.0 in the USA; and Autos per 1000 people are 6.0 in China versus 475 in the USA. This lull in the economy has produced a narrow surplus in oil production versus demand. Yet per capita commodity consumption demonstrates that developing market demand is still at an early industrialization stage. If some economists are right that we've turned the corner on the housing slump, contributing to improved world GDP in 2007, it is unlikely that commodities will experience much of a decline from these levels. This bodes well for commodities and emerging markets.
posted by WRA Strategy Group at 8:59 AM
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