Some Thoughts About EM FX and Equity Performance In 2011
By Win Thin
Now that we are about halfway through Q1, we thought it would be helpful to take a look at how equity markets have performed so far this year. The tables below summarize MSCI performance for a variety of countries and regions for 2009, 2010, and YTD through February 15. We note that so far in 2011, EM equities continue to lag DM. MSCI Developed World is up 5.0% YTD, MSCI US is up 5.6% YTD, and MSCI EM is down -4.1% YTD. This comes after strong outperformance by EM in 2009 and 2010. Within EM, MSCI Asia is down -4.1% YTD, MSCI EMEA is down -3.8% YTD, and MSCI Latin America is down -4.3% YTD. Tighter monetary policy is typically negative for equity markets at the outset, but we believe there is more to the story. As we have noted before, EM tightening is falling short of what needs to be done due to concerns that higher rates will lead to currency strength. As such, more and more EM countries are being viewed as behind the curve and so the current period of EM underperformance could continue until more signs are seen they are getting back ahead of the curve.
The interesting thing to note is that currency performance is not mirroring equity market performance very well so far in 2011. In 2009, out of the 23 major EM countries listed below, equities and currencies both moved in the same direction for 19. In 2010, this number fell slightly to 18. So far in 2011, this number comes in at only 14 and so we are seeing more cases of equity market weakness coupled with currency strength. This seems at odds with what we’ve seen over the past two years, so it would seem likely that either those equity markets rebound or their currencies play catch up with falling equities and weaken too.
Looking at the individual markets will shed some light on this behind the curve argument. In 2009 and 2010, investors could just by EM across the board and close their eyes, but 2011 will require much more differentiation amongst markets. In Asia, the worst performing markets YTD as measured by MSCI are India (-12.9%), Philippines (-11.0%), Thailand (-7.8%), and Indonesia (-7.7%). These countries all have high or rising inflation coupled with minimal policy response and are seen as being behind the curve. The best performers are Malaysia (-0.1%), Korea (-0.5%), Hong Kong (-2.1%), China (-3.0%), Singapore (-3.2%), and Taiwan (-3.6%). For the most part, these countries have low or stable inflation and/or aggressive policy response. The one possible exception is Korea, where inflation is above target but the BOK is hiking at a cautious pace. In Asia, biggest opposing divergences between equity and FX performance YTD are in Philippines and Indonesia, with both IDR and PHP up YTD despite falling equity markets.
In EMEA, the worst performing markets YTD as measured by MSCI are South Africa (-11.1%) and Turkey (-6.9%). Investors have been spooked by Turkey’s unorthodox experiment with cutting rates and raising reserve requirements, while South Africa is being hurt by perceptions that SARB will be unable to hike rates in response to rising inflation due to the weak economic backdrop. The best performers are Hungary (9.1%), Czech (6.0%), and Russia (4.7%). Of note, Hungary has been able to reverse negative investor sentiment after fiscal and monetary tightening. Russia inflation is approaching double digits, but the CBR appears willing to allow greater RUB appreciation and has started the tightening process. High oil prices are boosting Russia equities, but the policy response bears watching. In EMEA, there are no opposing divergences between equity and FX performance YTD.
In Latin America, the worst performing markets YTD as measured by MSCI are Peru (-13.2%), Chile (-9.9%), and Argentina (-6.5%). This is particularly surprising, as we believe Chile and Peru are ahead of the curve and continue to hike rates in response to strong growth and price pressures. The best performers are Mexico (-3.4%), Brazil (-5.0), and Colombia (-5.5%). Mexico inflation eased in January and gives the central bank leeway to remain on hold. We do see risks ahead for both Brazil and Colombia. Colombia has kept rates steady despite a strengthening economy, and so investor sentiment could worsen if the policy response proves lacking. Brazil is holding up well, but there are concerns that the reliance on macro prudential measures may not be enough to rein in rising inflation. This too bears watching. In Latam, biggest opposing divergences between equity and FX performance YTD are in Peru and Mexico, with both PEN and MXN up YTD despite falling equity markets. Note that COP is virtually unchanged YTD despite a falling equity market.