Will emerging market outperformance last?

The MSCI Emerging Markets Index has notched up a massive 72,3% gain for the year to date and an even more impressive 101,4% since the March 9 lows this year, significantly outperforming developed markets.

“Emerging markets were the clear leaders during the initial months of the global economic recovery,” says Dr Prieur Du Plessis, Plexus group chairman. Although the MSCI World Index has subsequently done some catching up, it still lags with gains of 26,7% and 69,3% respectively for the two measurement periods.

“This raises the question of whether emerging markets should be renamed ‘emerged’ markets,” says Du Plessis. “To address this, one should gain a better understanding of the key drivers of emerging stock markets.”

He says the Emerging Markets Index is primarily driven by commodity prices and, in particular, by metal prices as measured by the Economist Metals Price Index. Considering the historical relationship, he believes emerging-market equities seem to be fairly priced given the level of metal prices.

“All other things being equal, the outlook for emerging markets, or at least the resource-related ones, appears positive given the favourable prospects for metal prices on the back of improving global industrial production and stronger global economic growth,” he adds. This obviously bodes well for the South African stock market over the medium to long term as there is a close correlation between metal prices in rand terms and the FTSE/JSE All Share Index.

Du Plessis says it is important to note that the ratio of the Emerging Markets Index and World Index is also driven by commodity prices and specifically metal prices. “The relative risk of investing in emerging-market equities has increased as the ratio has outrun metal prices,” says Du Plessis.

“Over the longer term I have little doubt that emerging markets will outperform their mature peers,” says Du Plessis. However, over the next few months metal prices would need to rise quite substantially to ensure further outperformance by the Emerging Markets Index.

“At best, I expect emerging markets to maintain the current relative levels against the MSCI Global Index should metal prices move sideways,” says Du Plessis.