Market Overview, April 2010

Diversification is one of the time-honoured principles of investing – the “don’t put all your eggs in one basket” notion that spreading stock investments across countries and regions will reduce risk.
In last March and April Market Overviews, I glowingly extolled the virtues of diversification. A year on … let’s revisit this old belief. However, as my mother used to say before heading down to the High Street shops: “let’s first take a look at the markets”.
Global first quarter results were positive given the strong month of March performance for most equity markets. This occurred despite increased nervousness about the European PIIGS (Portugal, Ireland, Italy, Greece and Spain) and a sharp increase in commodity prices. Since then, Europe has rescued Greece and this should moderate investor concern for the region.
Of the positive performance witnessed globally in March, Russia led the rally aided by surging oil prices. Indian equity markets posted strong gains fuelled by the positive post-budget buying spree. The Chinese equity markets were also up. Nevertheless China remained to be the laggard compared to most emerging and developed markets.
With the price of crude surging to well above $80/barrel in March, investor appetite for Russian stocks followed suit. This trend has continued into April and we saw $87/barrel last week.
Russia remains one of the most attractively priced emerging markets we monitor.

China
The Chinese equity markets have been underperforming and in general, the markets were held back by the following major worries: fiscal tightening to control rampant credit growth from 2009; inflation and the property bubble talk.
As for the property bubble, most major bubbles are precipitated by the use of leverage. In China, household debt is about 17% of GDP compared to 96% in the US and 60% in the EU. Buyers are required to put 30% down payment for their first home and 40% for their second. In many cases, people buy their homes with old-fashion cash.
Clearly, China does not have an overleveraged domestic household economy. So if the property market does correct, the broader economy and the banking systems are unlikely to take a direct hit, as in many other economies. On the positive side, we expect the Renminbi (RMB) will start to appreciate. It seems China is softening its stance and beginning to prudently relax its exchange rate policy, resuming the gradual appreciation of RMB.
India
The market response to the budget announcement was largely positive. Major highlights from the budget will shift more power to consumers, especially to the lower income class and rural farmers as duty, and other forms of income tax were lowered; rise in corporate tax to boost infrastructure spending; nearly 1.4 trillion rupee was committed by the government to spend on infrastructure projects.
Rising inflation remains a threat. The headline inflation rate, as measured by the wholesale price index (WPI) touched a 16-month high of 9.89% in February. The earnings estimates for most Indian companies remained largely unchanged for the 2-3 quarters.
The banking and property sectors were still the market laggards.
Middle East & North Africa (MENA)
The momentum of the MENA markets was helped by improving global sentiment and a strong oil price. Dubai was the best performing market by far, rising 15.7% over the course of the month. Better than expected news surrounding the restructuring of the Dubai World debt positively surprised and boosted the market, especially banks and real estate stocks.
The Qatari market also had a good month gaining 8.4% triggered by the government announcing a better than expected budget for 2010-2011.
Frontier Africa
IMF estimates that the continent’s real GDP will grow on average by 4% this year although their forecasts for Sub-Sahara Africa ex South Africa are considerably higher.
Stocks in the smallest developing markets are beating their larger peers by the most in almost five years and recently Templeton Asset Management’s Mark Mobius confirmed they will keep rallying as consumer demand picks up.
Although Africa has lagged some other emerging markets over the last 12 months, it performed conspicuously better than developed markets over the last quarter. Also it is interesting that Africa ex South Africa outperformed South Africa over the last quarter, whereas in 2009 Africa ex South Africa lagged South Africa in 11 months out of 12.
This powerfully suggests investor confidence is at last beginning to return to Africa’s frontier markets. Some of the world’s best performing markets YTD are found in frontier Africa, with Nigeria and Kenya leading the way, both up by more than +25%. The good news for investors is that there is much more upside to come.
We believe the long term trend of value creation for investors in Africa has only begun.
Rethinking diversification
Faith in diversification was one of the many casualties of the financial meltdown, as even the most diversified stock portfolios took a big hit.
Earlier this month, four academics from Canada’s McGill University released a surprising paper examining the degree to which different stock markets operate in tandem. To the extent that stock markets move in lock step, downside protection in declining markets is minimal.
Historically, many of the fundamental principles that guided investors were a matter of faith.
Increasingly, it’s possible to look at some of these beliefs under the microscope of hard data – some stand up to scrutiny, others don’t.
When it comes to the benefits of geographic diversification in reducing stock risk, the message is clear. First, diversification across developed markets offers limited protection against risk.
Diversification into emerging markets offers more risk reduction, although that appears to be shrinking as well. As a result, investors will more and more have to look for strategies beyond geographic diversification in order to reduce risk.
Your choices: Offsetting that, for the five years to last June at least, the data indicates that during market crises when investors need diversification the most, the case for emerging markets remains strong.
And that’s perhaps the most powerful argument of all for emerging markets.