Rama Krishna Vadlamudi, Hyderabad 10 August 2013 www.ramakrishnavadlamudi.blogspot.com
Page 2 of 5The MSCI EM index has outperformed both the S&P 500 and MSCI EAFE indices ineight out of ten years between 2003 and 2012. The equity returns are depicted in theabove graph. Only in 2008 and 2011, the emerging markets equity returnsunderperformed both the US equities; and world equities (ex-US and Canada).During the current calendar year 2013, the emerging markets have underperformed theUS equities, as well as other developed markets. What is troublesome for marketparticipants now is that the underperformance is very large. While the MSCI EM indexhas fallen by about 10 percent, the S&P 500 has surged by 18 percent, indicating anoverall underperformance of about 28 percent for emerging markets in 2013 so far. Thisunderperformance is due to fall, in the range of 10 to 20 percent, of equities in Brazil,Russia, China and India.In Japan, the Prime Minister Shinzo Abe has vowed to double the country’s monetarybase in two years—with Bank of Japan injecting massive doses of liquidity into themarkets, in order to boost the crippled economy and tackle the entrenched deflation.Following this, the Japanese Yen has depreciated against the US dollar by 11 percent in2013, while the Nikkei stock market index has shot up by 31 percent. Stock markets inthe UK, Germany and France too have gone up this year.
What Caused this Underperformance of EMs in 2013?
In May this year, the US Federal Reserve had hinted at tapering of its bond buyingprogram (QE3). It was perceived that the tapering would start in September this year andwould end by the middle of 2014. The markets have taken this news of US Fed taperingvery negatively. Even though attempts have been made to assuage the marketssubsequently, the market perception has not changed. The US Fed, the IMF and the ECBhave tried to calm the nerves of financial markets, by saying that they’ll try the easymoney policies as long as their economies remain weak. The reality is that one day thesecentral banks have to stop their massive liquidity injection programs, resulting in largemoney outflows from emerging to developed markets.With the hint of US Fed tapering, global investors have started selling securities, bothequity and bond, in emerging markets and taking their funds back to the developedmarkets. The yield of 10-year US Treasury note has increased from 1.6% in May to thecurrent 2.58%, attracting funds back to the US markets, in some sort of trend reversal.
(As part of its Quantitative Easing 3 or QE3 program, the US Fed is committed to buyingbonds worth $85 billion per month. When central banks buy bonds, they inject liquidity intothe banking system. The massive monetary stimulus from developed economies since the2007/2008 Global Financial Crisis, particularly the US Fed, has resulted in enormousliquidity, said to be about $12 trillion, in the world fuelling price inflation in the emergingmarket equities/bonds and world commodities. This excess money has been circulatingaround the world, chasing returns and yields.)