TODAY: EMERGING MARKETS EDITION!

I just enjoyed reading Ruchir Sharma’s The Rise and Fall of Nations, and have thus been thinking more about emerging markets. This will be the theme of today’s zig-zagging (some might say disjointed) piece. No overarching thesis or agenda, as per usual; just getting the lay of the land and pointing out a couple of things I find interesting.

Since the term was coined, ’emerging markets’ has been a problematic phrase: it refers to so many varied countries that I almost question the premise of this piece. Alas, I will not be doing much to remedy this problem. In the near future, I will be doing some deeper pieces on individual countries, which will hopefully bring some granularity to my EM writing.

First, here is a brief graphical history of the past three decades of EM equities (in log terms, of course):

And here is a chart from Citi’s Matt King showing net flows to EM since 2000.

And here is a Bloomberg pull of YTD performance across EM asset classes (spoiler: there’s a lot of green):

THE EM-COMMODITY STORY: FALLING R^2

From 2000–2009, the R-squared of MXEF against BCOM was 76%. This means that 76% of the change in the MSCI Emerging Markets Index (MXEF) could be predicted by a linear relationship with the Bloomberg Commodities Index (BCOM). Since the financial crisis, the power of this explanatory variable has declined to 41%. See regressions below. Basically, from 2000 to 2009, commodity prices were rising and emerging markets were rising. An important cause of this was aggressive Chinese investment and consequent demand for raw goods. Since the financial crisis, however, commodities have been extremely weak while EM has managed to hold its own. The logical conclusion (and it is borne out by further examination) is that emerging market economies are less reliant on high-priced commodity exports to maintain economic growth and corporate profitability. Also, it doesn’t hurt that accommodative monetary policy has flushed world equity markets with a bid floor.