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Will Emerging Market Outperformance Last?


The only way this will continue is if metal prices substantially rise.

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 low. Although emerging markets were the clear leaders during the initial months of the recovery, the MSCI World Index has subsequently done some catching up but still lags with gains of 26.7% and 69.3% for the two measurement periods.

The chart below shows the performance of the MSCI Emerging Markets Index relative to the Dow Jones World Index. Needless to say, an upwardly sloping line means outperformance by developing stock markets.

Should emerging markets be renamed "emerged" markets? Let's consider two graphs to gain a better understanding of one of the key drivers of emerging stock markets.

As shown below, 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, 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 favorable prospects for metal prices on the back of improving global industrial production and stronger global economic growth.

What's important is that the ratio of the Emerging Markets Index and World Index is also driven by commodity prices and, specifically, metal prices. As shown below, the relative risk of investing in emerging-market equities has increased as the ratio has outrun metal prices.

Longer term I have little doubt that emerging markets will outperform their mature peers. 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'd expect emerging markets to maintain the current relative levels against the MSCI Global Index should metal prices move sideways.

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