In March, Indian equities outperformed their emerging market peers by 120 basis points (bps). This brings the year-to-date outperformance of the Indian equity market versus the MSCI Emerging Markets Free (EMF) Index to 270 bps.
At a global level, we maintain our recommended underweight stance towards the Indian equity markets, owing to valuations—Indian equities trade close to 17 times their 12-month forward earnings, a large premium to the historical average relative valuation premium levels of Indian equities and positioning. Dedicated global emerging market institutional investors are overweight on Indian equities and local Indian investor sentiment metrics remain optimistic.
Graphic: Ahmed Raza Khan/Mint
In March, emerging market equities, as represented by the MSCI EMF Index, outperformed world equities, represented by the MSCI All Country (AC) World Index, by 157 bps. Specifically, in March, the MSCI AC World Index rose 6.43% against an 8% rise for the MSCI EMF Index. Within the emerging markets space, total return leadership was held by Europe, Middle East, Africa (EMEA) region, rising 10%, followed by the Asia-Pacific (ex-Japan) group, which rallied 7.3% and Latin America, as the laggard region in terms of performance, with the regional stocks rising 6.9%. EMEA region’s return leadership in March was accompanied by a sharp acceleration in investor inflows.
Finally, among the so-called Bric group, India and Russia outperformed the MSCI EMF Index, while Brazil and China underperformed.
Emerging markets’ solid outperformance of developed market peers in March was accompanied by a sustained acceleration of investor flows not only into emerging market equity mutual funds but even more impressively into emerging market bond funds. As a result, emerging market bond spreads have compressed to the lowest level since December 2007. From a relative valuation perspective, emerging market equities have become significantly cheap to emerging market bonds.
Another dynamic lending further support to emerging market equities stems from the merger and acquisition (M&A) sector. Specifically, not only have monthly M&A volumes been on a rising trend since the beginning of 2009, but even more impressively, the share of emerging market countries (as a target in global M&A transactions) has been tabulated by analysts at JPMorgan Chase and Co. at close to 30% currently, from levels close to 10% in 2007. Such dynamics enhance the scarcity value of emerging market equity instruments.
Over the first quarter of 2010, emerging market equities have slightly underperformed their developed market peers (by around 60 bps). Arguably, some of the principal factors adversely affecting emerging markets’ relative return performance during the period include the Chinese monetary policy tightening measures adopted early in the year, mounting sovereign credit concerns fuelled by Greece’s debt crisis and global market concerns over the effect on liquidity conditions in sensitive markets, emanating from the end of quantitative easing measures in the US.
Against the backdrop delineated above, we continue to embrace the thesis that emerging markets are likely to retake their global return leadership role sometime in the second quarter as tightening measures across most of the world’s largest emerging market countries are significantly priced into the money market curves.