Emerging Markets Will Outperform Over the Next 12 Months

Emerging markets were again the star performers as, after a disappointing second quarter, global equities rebounded strongly in July. The rally was catalyzed by positive developments surrounding European economic risks and rising commodity prices. The MSCI Emerging Market Index gained 8 percent, outpacing the S&P500 by 1 percent.

As I had forecast, cyclicals handily outperformed the defensive sectors. This will propel the Silk Road Investor Portfolio to another outperformance versus its benchmarks for the third quarter.

Although the pace of economic growth in the US and Asia slowed, positive news from Europe had a substantial and positive impact on investor sentiment this time around.

Europe started the second half of the year off strong, with accelerating growth in both the manufacturing and the services sectors–contrary to perpetually pessimistic projections by the Anglo-Saxon economic establishment. Much of this criticism is founded on sound evaluations of the long-term picture. But while this “impending calamity” remains a ways off, the coming has been told so often that it’s now more like background noise–there’s no utility from these arguments in forming a short- to medium-term outlook.

The Eurozone composite Purchasing Managers Index (PMI) rose to 56.7 in July from 56.0 in June. Germany’s manufacturing PMI jumped to 61.2 from 58.4. France’s service-sector PMI rose to 61.3. Industrial orders in the Eurozone grew 3.8 percent in May, following a 0.6 percent gain in April. These are fairly strong numbers, all in expansion territory and produced during uncertain times.

Only seven of 91 financial institutions failed to pass European stress tests: five banks in Spain and one each in Germany and Greece. The seven are expected to face a total capital shortfall of EUR3.5 billion. Though the stress tests may not have been as stringent as many purists would have desired, they have, for now, achieved the important purpose of reassuring markets about the resilience of Europe’s banking sector. Purists’ fears aside, the tests were neither more nor less rigorous than similar exercises performed in other jurisdictions. In the relative world we live in, this is more than one can ask for. European stocks moved higher on the results, as investors put aside fear and focused on the stronger-than-expected economic data.

Materials rallied on news that China would tighten no more in the immediate term and that activity in the country’s housing sector picked up. On 19 July China announced the allocation of RMB60 billion (USD8.85 billion) for the construction of 5.8 million affordable housing units. This money will most likely be spent in central and western China where the economy is underdeveloped; these regions have been the focus of the government’s new economic growth initiatives. I continue to expect governments around the world, led by the US and China, to do whatever is necessary to avoid a double-dip recession.

The turning point for Asian markets will come in September or October, as inflation will moderate, policy tightening will slow and growth concerns will abate as investors recalibrate their (until recently) overinflated expectations. Emerging markets, particularly those identified in the Silk Road Investor Fresh Money Buys protocol, are the place to be.