It wasn’t just the BSE Sensex that powered its way to new highs on Friday. The MSCI Asia Pacific index surpassed its previous peak reached on 11 October, the Hang Seng index soared past the 30,000 mark, oil breached the $90 (Rs3,555) a barrel level and gold rose to its highest price in 28 years.
After the hiccups caused by the Securities and Exchange Board of India clampdown on participatory notes (P-Note), it is back to business for the Indian markets. The overarching theme remains that of a rush of funds to emerging markets, based on the near-consensus view that they offer a safe haven away from the credit and housing crises affecting the US and some other developed economies. True, the momentum of the flows has diminished, but everyone’s betting on another rate cut by the US Federal Reserve on 31 October to add more fuel to the fire.
A look at fund flows confirms the belief in the safe haven theory. According to EPFR Global, a research outfit that tracks global fund flows, “Emerging market equity funds lost some momentum during the third week of October, but absorbed a net $3.3 billion as investors stuck to their strategy of rotating out of developed market asset classes into cash, emerging markets and precious metals.” On the other hand, US, Japan and Europe equity funds saw net outflows of $6.1 billion.
There’s another way of looking at what is happening. Although the MSCI World index is up a mere 0.12% this month to 25 October, the MSCI BRIC (Brazil, Russia, India, China) index is up 9.2%, while the MSCI Emerging Markets index is higher by 6.56%. The outperformance persists for longer time periods. It can be argued that this doesn’t prove a lack of correlation—all that is happening is that emerging markets are doing better than the US, and if the US market falls dramatically, so will the emerging markets. That may well happen and it’s a fact that every morning traders in emerging markets look to what the Dow has done the previous evening, although recently there have increasingly been occasions where our market has charted out its own path.
Is the consensus belief justified? In a recent research report, Citigroup Inc. strategist Markus Rosgen and his team bust the myth that Asia can decouple from the US. They underline the increased correlation between the Asian and US markets, point out that consumption to GDP ratios have been declining for Asian economies and argue that Asian economies cannot pursue a monetary policy independent of the US.
But perhaps “decoupling” is the wrong word to describe investor behaviour. Consider, for instance, that the MSCI BRIC index has delivered an annualized return of 11.96% or that the Emerging Markets index has given returns of 10.66% over the last 10 years and then compare that with the 4.78% returns provided by US equities over the same period, less than half of the emerging market gains. To cut a long story short, investors may finally be responding to relative performance and rotating money out of developed markets into emerging markets and this process is being spurred on by the economic and credit market worries in the US.
Where does India stand in relation to other Asian economies? The Citigroup report has several interesting charts. One of them shows the correlation of Indian GDP growth with the US is 0.22, the second lowest among the 10 Asian countries listed, and well below Asia’s average of 0.62. Indonesia has a correlation of 0.18, while China’s correlation with the US is 0.28. Is it any wonder then that these three have been the best performing markets in Asia in the last three months? In the current month, as of 25 October, MSCI China is up 13.1%, India 9.39% (despite the P-Note sell-off) and Indonesia 13.85%.
Incidentally, the Citi report also points to the increasing correlation between the Chinese and Indian markets, thanks to the BRIC concept. As the theme becomes more important and BRIC funds proliferate, our markets could, despite being very different from each, increasingly march to the beat of the same drummer. It’s still a long way from happening—parts of the Chinese market are still closed to foreigners—but it’s the reason why we’re hearing more and more comparisons of Indian price-earning multiples with the stratospheric Chinese multiples.
The International Monetary Fund Survey magazine supplies other reasons for the attraction of emerging markets. In purchasing power parity (PPP) terms, India was second only to China as the main driver of global growth in 2006, and is set to achieve that distinction this year also, contributing a little more than 10% to global growth on a PPP adjusted basis. China continues to be the main contributor to global growth, even if output is measured at market prices instead of in PPP terms. India falls behind the US, the Euro area and Japan if output is measured in market prices, but its?contribution?to?global growth is still a significant 5% or so.
What’s more, it’s not just the emerging secondary markets that are attractive. A recent report by Ernst & Young said an early half of the $57 billion raised globally by initial public offerings (IPO) in the third quarter was by companies in the BRIC countries. Also, the surge in IPOs from these countries offset a decline in IPOs elsewhere in the world. That’s another reason for money to flock to the BRIC economies.
Mint’s resident market expert Manas Chakravarty looks at trends and issues related to investing in general and Indian bourses in particular. Your comments are welcome at firstname.lastname@example.org.