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Emerging Markets Rally Gets Support From $890 Billion Norwegian Gorilla


Is this the start of a new EM run?

Don't look now, but much maligned emerging equities are mounting a sustained rally.  The iShares MSCI Emerging Markets ETF (NYSEARCA:EEM) has gained 18% since Feb. 1, beating the 13% rise in the S&P 500 (INDEXSP:.INX), whose new records have grabbed all the headlines.  The five months of outperformance is remarkable considering that two heavily weighted EMs, China and Russia, are stuck in the doldrums -- China due to investors' fear of financial and housing bubbles, Russia because of its indecisive imperialism in Ukraine.

To compensate for the flat returns from these two BRICs, most other emerging bourses have been going great guns.  India (BATS:INDA), a commodities importer with a new leader who inspires high hopes, has jumped 30% since February. But Brazil (NYSEARCA:EWZ), a commodities exporter with a tired old leader whom nobody likes, has advanced by 20%.  Indonesia and Turkey are "Fragile Five" nations whose currencies were supposed to be on the brink of collapse thanks to profligate current account deficits; Mexico is a macroeconomic model whose export engine to the US keeps its accounts close to balance. The result has been the same: surging stock markets.

It is about time to ask whether these gains are just a rebound from the punishment emerging markets endured during the "taper tantrum" last autumn, when investors feared a great sucking sound of unwanted pesos, lire, and rupees as fast money rushed back to better-paying T-bills, or if they are the start of a new EM run.

A quiet but weighty vote for the new-run scenario came today from Norway's sovereign wealth fund, which at about $890 billion is the largest hunk of investable state funds in the world.  Norges Bank Investment Management, the central bank department that oversees this trove for the oil-rich, population-poor Scandinavian nation, is no superstar manager. It boasts an average 6.3% annual return since 1998.  But it is the very definition of a solid, cautious, long-term institutional investor, the kind every company and nation dreams of holding its securities.

"Our most important concern is to safeguard the long-term purchasing power of the fund," NBIM offers as a mission statement in the investment-strategy summary that it issues just once every three years.  To that end, it has traditionally hewn to the familiar and dependable.  Two-thirds of its "larger" equity investments are reserved for European corporations.  Its real estate holdings stick to London and Paris in the old world, New York, Washington, Boston, and San Francisco in the new.

All that may be about to change a little, NBIM hints in its 20-page public summary, and a little in percentage terms goes a long way when you are deploying $890 billion.  The report infers obliquely that the emerging markets share of the fund's holding will rise to at least 5%, though it is unclear what the current number is.  It states clearly that it will hike investment in so-called frontier markets, an inexact term encompassing countries from Colombia to Vietnam to Cameroon. The Norwegians also intend to increase local-currency bond holdings, a nice nod toward emerging-market coin that was all supposed to be binned in favor of the almighty dollar.  "New frontier markets will be added to our equity investments and the scope of our fixed-income investments will be widened to include additional currencies," notes the strategy brief, which covers the years 2014-16.  Even NBIM's stolid property department will start looking for opportunities in "global cities outside Europe and the US."

In sum, the super-deep Norwegian pocket offers a solid if not ringing endorsement for superior returns in emerging markets going forward.  With all the bad news about maniacs in Iraq and saber rattling from China front and center, it's easy to forget that world economic growth is at last accelerating to a more or less healthy pace. The International Monetary Fund projects a 3.7% expansion this year and 3.9% in 2015, compared to 2.9% in 2012.  With worldwide GDP somewhere between $72 trillion and $85 trillion depending on how you measure it, that one percentage point is far from trivial. Emerging markets, particularly the smaller ones, are still akin to the tail on the global economic dog, getting more than their share of movement as the whole beast heats up or cools. 

In the longer term, the Norwegians recognize, global economics continues to rebalance toward the developing world, whatever the fits and starts involved.  The Dow (INDEXDJX:.DJI) and S&P record-breaking may have distracted US attention from that fact for the moment, but the wise investor will keep it in mind.
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