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Canadian stock market investors have enjoyed a better summer than most as surging gold stocks have helped our market finally play some ‘catch up’ to the rally in the rest of the world after lagging global markets dramatically over the prior two years. But the strong move here (at least for those who own or added to their gold stocks) has contrasted with market performance outside of North America, where developing economies (referred to as Emerging Markets) have struggled, leading many pundits to euphemistically refer to them as the “SUBmerging Markets.”
The prospect of higher long-term growth had lead to strong performance of emerging economy stock markets from India to Brazil to China to Russia to Turkey to Egypt over the past twenty years. But this appears to have reversed course dramatically in the past two years as investors worried about political and growth problems in many of those same developing economies and instead have shifted back to the U.S., where a stable political environment and strong domestic growth made the U.S. stocks the ‘place to be.’ Almost $95 billion was poured into exchange-traded funds (ETFs) of American shares this year, while developing-nation ETFs saw withdrawals of $8.4 billion. This comes after a year of exceptionally strong gains for the U.S. market, with the S&P500 Index gaining over 18% over the last 12 months, one of the best performances, next to Japan, of the major global stock indices. It also puts the U.S. stock market at a higher valuation then it has been since 2008, trading at 16 times profit, 70 percent more than the MSCI Emerging Markets Index. A measure of historical price swings also indicates the U.S. market is the calmest in more than six years compared with shares from China, Brazil, India and Russia.
The biggest worry for investors in the short term is what happens at the Fed meeting in September, where the monthly purchase of US$85 billion of Treasury Bonds as part of its Quantitative Easing (QE) program. As the U.S. Federal Reserve moves closer to the ‘tapering down’ of its QE program, interest rates in the world’s largest economy have moved higher, drawing funds from some of the emerging economies that are dependent on capital inflows, such as Malaysia and the Philippines. This has put downward pressure on those stock markets. The MSCI Emerging Markets Index is down 11.6% so far in 2013, a far cry from the 16.2% gain of the S&P500 Index over the same period.
The difference can be seen clearly in the chart below, which shows the performance of G7 stock markets (US, UK, Japan, Germany, France, Italy and Canada) versus that of the Emerging Markets (broad measure with biggest single country weight being South Korea and China, each at around 15%). While the Emerging Markets had a much better recovery off the 2009 lows, lead by China, the G7 markets have taken the lead since the 2nd half of 2011. That divergence also coincides with the peak in commodity-based stocks in mid-2011. The gap has widened further this year amidst worries about slower growth in China, economic problems in India, much slower growth in Brazil and headline political unrest in Turkey, Egypt and now Syria.
Developing countries are also becoming a bigger part of the global economy as their growth rates exceed that of the developed world. Their bigger relative importance also introduces some greater overall risks, given the greater volatility of those markets. Developing markets have taken in over US$4 trillion in net private capital over the past five years. Clearly the risk of a reversal in these flows is what is unnerving investors.