Prieur
du Plessis
submits:
Emerging-market equity prices as measured by the MSCI Emerging
Markets Free Index are primarily driven by commodity prices and in
particular by metal prices as measured by the Economist Metals
Price Index. Currently emerging-market equities are approximately 8
- 10% overpriced given the level of metal prices.
Click on charts below to enlarge:
Sources: I-Net Bridge; Plexus Asset Management.
The ratio of the MSCI Emerging Market Free Index and MSCI Global
Index is also driven by commodity prices and specifically metal
prices. On a relative basis emerging-market equities tend to bottom
earlier than mature markets and the ratio therefore acts as a
leading indicator of metal prices. At this stage the still-rising
and elevated level of the ratio suggests that metal prices are
likely to hold up well despite the recent sell-off.
Sources: I-Net Bridge; Plexus Asset Management.
The yield on the JP Morgan Emerging Market Bond Index is at its
lowest on record. Sentiment regarding emerging-market bonds is also
significantly influenced by metal prices. The JP Morgan Emerging
Market Bond Index yield (please note the reverse axis) has dropped
significantly more than what metal prices suggested and therefore
points to increased risk in emerging-market bonds.
Sources: I-Net Bridge; Plexus Asset Management.
Emerging-market bond yields took their cue from mature-market
bonds, though, as the yield spread narrowly tracks that of the
Metals Index. However, the yield spread (please note reverse axis)
is currently 50 basis points lower than what it should have been
given the current levels of the Metals Index. It therefore also
indicates that emerging-market bonds are expensive relative to
mature-market bonds.
Sources: I-Net Bridge; Plexus Asset Management.
The yield spread between the JP Morgan Emerging Market Bond
Index and the calculated mature-market bond index is even lower
than the range that existed before the economic malaise started in
2008. It will need a big push in metal prices to reduce the spread
further.
My equally-weighted commodity currency index − consisting of the
Australian dollar, Turkish lira, Brazilian real, Czech koruna, Thai
baht, Hungarian forint, Russian rouble and SA rand - is driven by
the same forces behind investments in emerging markets, namely
metal prices. For some unknown reason the commodity currency index
lagged and opened a gap with metal prices towards the end of last
year. The gap closed only recently.
Sources: I-Net Bridge; Plexus Asset Management.
The commodity currency index has an inverse relationship with
the yield spread of emerging-market bonds to U.S. treasuries,
thereby indicating that commodity currencies rise when the risk of
investing in emerging markets − as measured by the yield spread -
declines and vice versa.
With the emerging-market bond yield spread expected to widen
somewhat in the short term, commodity currencies can be expected to
follow suit and weaken.
Sources: I-Net Bridge; Plexus Asset Management.
My country's currency, the South African rand, is currently
slightly (5%) overvalued against the commodity currency index.
Sources: I-Net Bridge; Plexus Asset Management.
Bar the current situation where emerging-market equities and
bonds are somewhat overpriced and a healthy market correction is
needed to pull them back to realistic levels compared to mature
markets, the longer-term outlook for investment markets in emerging
economies is cloudy and becoming increasingly uncertain. Despite
QE2, I see no quick fix to substantially boost consumer sentiment
in the U.S., especially in light of the absence of new fixed
investment given the significantly surplus capacity, severe
problems in the housing market and the inelasticity of job creation
to stimulatory measures.
Furthermore, global demand is likely to remain under pressure. I
expect demand in the Eurozone to be lethargic, especially in light
of the fiscal crisis in the PIIGS, Japan running the risk of
returning to a recession, and emerging economies and China in
particular reigning in their economies by hiking interest
rates.
I do not see emerging-market economies tanking, though, but in
my opinion the short-term risk of investing in emerging markets has
increased significantly.
Disclosure
: None
See also
Steve Jobs: MarketWatch's CEO of the Decade
on seekingalpha.com