With inflation hurting emerging markets and the U.S. yield curve sending mixed signals, it may be too soon to label the current path 'sustainable.'
In January’s Racing To The Cliff?, I highlighted how I might have been overly skeptical of the stock market’s rally and the economic recovery overall. Since Sept. 30, when I reasoned the risk didn’t justify the reward, the S&P 500 has climbed more than 17 percent and the Russell 2000 over 20 percent. Emerging markets, however, have been flat to down over that time frame amid increasing inflationary pressures.
The premise I laid out then is still intact based on the fact that much of this inflation has been caused or exacerbated by the very same policies that are lifting the U.S. markets. Specifically, tax cuts that are adding to the federal budget deficit, plus the Fed’s “quantitative easing,” highlight my concerns that policies designed to stimulate the economy could now be counterproductive.
A murky picture emerges when you look at performance of different parts of the market from the end of September, when markets began pricing in the QE2-related Treasury purchases. As the table below shows, developed countries including the U.S., Germany and Japan, have all dramatically outperformed their emerging market peers over this time frame.
The iPath MSCI India Index ETN (NYSEArca: INP) and iShares FTSE China 25 Index Fund (NYSEArca: FXI) are actually down 15 and 2 percent, respectively, over that time frame. Brazil, represented by the iShares MSCI Brazil Index Fund (NYSEArca: EWZ) has also been relatively weak as South America’s biggest economy steps up efforts to cool inflation as well.
|BAL||iPath Dow Jones-UBS Cotton Subindex Total Return ETN||49.99||96.21||92%|
|$TNX||US Treasury 10-Year Yield||2.51||3.64||45%|
|SLV||iShares Silver Trust||21.31||29.21||37%|
|$TYX||US Treasury 30-Year Yield||3.68||4.71||28%|
|DBA||PowerShares DB Agriculture Fund||27.48||34.83||27%|
|IWM||iShares Russell 2000 ETF||67.5||82.07||22%|
|EWG||iShares MSCI Germany Index Fund||22||25.94||18%|
|CRB||Reuters/Jefferies CRB Index||286.86||337.78||18%|
|SPY||SPDR S&P 500 ETF||113.53||133.11||17%|
|EWJ||iShares MSCI Japan Index Fund||9.82||11.32||15%|
|$WTIC||Oil - Light Crude - Continuous Contract||80.03||86||7%|
|EWP||iShares MSCI Spain Index Fund||39.45||41.4||5%|
|GLD||SPDR Gold Trust||127.91||132.32||3%|
|EWS||iShares MSCI Singapore Index Fund||12.92||13.35||3%|
|VWO||Vanguard MSCI Emerging Markets ETF||44.68||45.92||3%|
|$USD||US Dollar Index||78.72||78.4||0%|
|FXI||iShares FTSE China 25 Index Fund||42.65||41.68||-2%|
|LQD||iShares iBoxx $ Investment Grade Corporate Bond Fund||110.91||107.59||-3%|
|EWZ||iShares MSCI Brazil Index Fund||74.35||71.9||-3%|
|EMB||iShares JPMorgan USD Emerging Markets Bond Fund||109.02||104.58||-4%|
|INP||iPath MSCI India Index ETN||75.76||64.45||-15%|
|$VIX||CBOE Volatility Index||23.7||15.69||-34%|
The basic story above is that commodities are taking off and developed markets are well-bid, but emerging market equities are getting left behind as inflation—and concern about more of it—starts taking a bite. The inflationary challenges emerging markets have faced is clear in the chart below. It shows the outperformance since the beginning of November of the Thomson Reuters/Jefferies CRB commodity index over the iShares MSCI Emerging Markets Index Fund (NYSEArca: EEM), the most liquid emerging markets ETF.