Rocky Balboa View
The start of the year felt like a Rocky Balboa fight. Risky assets were absolutely pummeled during the first 6 weeks of the year and were down for the count.
Most investors were taken by surprise by the strength of the first punch and the retail section started emptying out early. White towels were being thrown about but out of nowhere equity markets started gathering strength.
Just like a fighter on the ropes biding time equity markets started little by little chipping away. By the end of February stocks had stabilized and the first real signs of a competitive fight emerged during the first week of March. The point count had evened out and by the end of the month the count had swung around in many categories. At the end of Q1 world equity markets were essentially flat but there were surprises galore.
The biggest surprise by far this year has been the re-emergence of Emerging Market Equities. The asset class had been left for dead after many years of disappointing returns, but this year the asset class is punching above its weight – already up 4.4% (MSCI EM).
EM equities have vastly out-performed developed markets especially those in Asia and Europe. A 9% gap has developed between developed and emerging international stocks (MSCI EAFE).
Despite the poor showing of the average Chinese stock how is it possible that EM equities as a whole are up for the year? No doubt investors are somewhat stunned by the YTD eye-popping returns to resource-oriented markets such as Brazil and Russia.
In our sample of global equities the average Brazilian stock is up over 24% while the average Russian equity is up about 16%. South Africa, another major EM market, punches in at an average stock return of close to 14%. Other emerging markets with average YTD returns exceeding 10% include Indonesia, Turkey, Chile and Malaysia.
Commodity markets have no doubt recovered, but is the strong performance of EM simply due to a recovering commodity market?
Precious metals have done very well this year with gold up 15% and silver up 9%. While $20 oil is still mentioned from time to time, energy markets have had a tenuous recovery but still show losses close to 10% for the year. Smaller components of commodity indices such as grains, livestock and industrial metals are all only slightly above water this year. Our conclusion is that there is more to the re-emergence of EM equity markets than simply a direct benefit from recovering commodity markets.
While broad based equity indices have gyrated at times like a punch drunk Rocky Balboa behind the scenes we have been witnessing a strong rotation toward out of favor sectors such as Energy, Materials, Utilities and Telecom. Momentum sectors of the past few years such as Health Care and Technology have receded.
The country and sector performance numbers indicate to us that global investors have been quietly changing their stripes. Glamour sectors and equity markets with the best post-Financial Crisis performance are being re-priced.
Part of this shift toward more value-sensitive sectors and regions may be driven by a desire to better protect the downside and capture yield in what most strategists would agree is a low capital market return environment.
We perceive that investors are changing their stripes. Valuation levels are being more carefully examined. Investors are also showing a desire for lower risk both from a return as well as financial statement perspective. Momentum strategies have lost their punch as have sell-side analyst recommendations.
Many of the characteristics typically associated with larger capitalization companies such as lower volatility, higher yields, stock buybacks and higher levels of profitability seem to be gaining favor among global equity investors.
We see global markets being more similar to Rocky Balboa – at times exhausted and bloodied but despite great hardships triumphant in the end. For the foreseeable future we see ourselves living in a risk on/off world with investor preferences increasingly tilted toward capital preservation strategies.
Click here to download the report: Less Bunny, More of a Rocky Balboa Market
Eric J. Weigel
Managing Partner and Founder of Global Focus Capital LLC