In the global village developed market equities and currencies continue to make the running. But for how much longer?
Good news about the US economy has led to the tapering that was first hinted at in May 2013 and became a reality late in the year. The Federal Open Market Committee announced on 18 December 2013 that it would begin reducing (tapering) the extra cash it injects into the US financial system through its bond and mortgage backed paper buying programme, for now from US$85bn per month to US$75bn.
The Fed also made it very clear that it did not expect to have to raise short term interest rates anytime soon and that all it might do by way of further tapering would remain US economic data dependent.
Long term interest rates in the US, and everywhere else, responded dramatically in May 2013 to the prospect of less support for bond prices and yields have remained on a generally upward path since then. The US equity markets were largely unruffled by the reality of higher interest rates. Good news about the US economy, as revealed by tapering intentions and action, was taken to mean better prospects for US corporations, despite higher interest rates. And so share prices rose further, especially in late December, as we show below.
In US dollar terms, the average emerging market equity went south rather than north in 2013, thus lagging well behind the trends registered on the developed equity markets (see below). Good news about the US economy did not translate into good news for emerging market economies.
Higher long interest rates in the US, that led to higher rates in emerging economies, including SA, put downward pressure on currencies and equities, when valued in US dollars. The one saving grace for interest rate sensitive economies and companies is that interest rate spreads between riskier bonds (including RSAs) and those issued by the US Treasury have tended to narrow recently, so moderating the impact of higher interest rates in the US (see below).
For now investors in emerging equity markets should hope that the expected recovery of the US economy is fully reflected in current long term bond yields. Indeed, economic disappointments (leading to lower bond yields) rather than surprisingly strong growth in the US (higher bond yields) would be greatly appreciated by emerging market equity and currency markets. Yet in any longer run view, a stronger US economy (given its large size) is good news for the global economy and especially for those emerging economies reliant on export flows to the developed world.
The better economic times seem more propitious for developed than for emerging markets and their valuations reflect this. In due course, the good economic news will spread to the emerging markets, their currencies and their equity and bond markets. For now developed equity markets, we think, continue to make the stronger case for equity investors than emerging equity markets, while equities generally make a much better case than bonds, given the risks of higher interest rates.
But a mixture of still more demanding valuations on developed equity markets and less demanding valuations on emerging markets, especially when measured in US dollars, could revive the case for emerging market equities and their currencies. At some point in time, the strong outperformance of developing equity markets and currencies will become the case for emerging markets that, after all, have the global economy in common. As they say, timing is everything.
