Emerging Markets Q2 Outperformance
While 2014 market consensus favorites such as the Russell 2000® (RTY), Nasdaq (CCMP), and Japanese Nikkei (NKY) trade down for the second quarter, very quietly the MCSI Emerging Market Index (MXEF) (Figure 1) has surprised with its Q2 outperformance.
Q2 performance to date
- MXEF +3.54%
- CCMP -1.87%
- NKY -5.30%
- RTY -5.65%
I suspect much of the stabilization centers on the surprising decline for the U.S. 10-Year Treasury yield (Figure 2), as well as favorable emerging market election results, for India in particular. The obvious question becomes, does the stabilization and subsequent rally in the MXEF suggest the unfolding of a larger 2014 bullish trend? Given the current collective evidence, I remain unconvinced.
- U.S. 10-year Treasury falls from 2.808% on April 2 to 2.4716% on May 15.
Emerging market assets suffered greatly just one year ago as the capital markets dealt with the Bernanke “taper tantrum.” In 2014 the surprise decline in Treasury yields both in the U.S. and Europe has placed investors and money managers back into a search for yield mindset. Emerging market assets in particular have been the beneficiaries of that yield search given their 2013 decline. However, I am cautious that the impact of even lower yields will translate into further significant favorability for emerging market assets. With the 10-year T-note at 2.5%, further yield downside is suggestive of strong headwinds to economic global growth, which will permeate into the emerging markets. Emerging market assets benefited from the move down in yields from 3% to 2.5%. However, please be aware that effect has most likely exhausted itself. Rather, accelerating emerging market economic growth is what is needed next to continue the current appreciation.
- Emerging market election results
The Indian Sensex (Figure 3) has rallied 23% since mid-September when Narendra Modi was named a candidate for prime minister. Later this month, Modi will officially become India’s prime minister. Much of the rally has been pricing in the impact of favorable Modi-directed structural reforms. Modi has a clear mandate given his majority victory to enact significant and unprecedented economic reform. However, it must be considered whether enough liquidity exists to achieve the Modi agenda. Although improving, India is still hamstrung with a large account deficit. Additionally, bond yields are still 150 basis points above last year’s 7% yield when the Bernanke taper tantrum began signaling tighter financial conditions.
Bottom line: Emerging markets’ quarterly outperformance is gaining significant attention from the media and investment banking desks. If, in fact, the current quarterly outperformance is to evolve into a trend for 2014, investors need to focus on external positive conditions beyond just favorable election results or falling developed world government bond yields.
Figure 1: MSCI Emerging Market (MXEF), January 2013 to Present
Figure 2: U.S. 10-Year Treasury, January 2013 to Present
Figure 3: India Sensex, May 21, 2013 to May 21, 2014