Why are emerging markets and large-caps rallying at the same time?, asks the FT’s John Authers in
Tuesday’s Short View column. The MSCI emerging markets index is at an all-time high, having erased the losses it suffered during the summer correction. That looks like a return to risk-taking as usual, he notes.But the performance of larger companies in the developed markets suggests a different dynamic. The Russell Top 50, covering the biggest US companies, briefly set a new high for the year on Friday and has strongly outperformed the Russell 2000 index of smaller companies over the summer. In Europe, Dow Jones’s Stoxx large-cap index has also regained its high for the year, while small stocks are lagging.When large caps are outperforming, it’s usually taken as a sign of conservatism or a flight to quality, notes Authers. “Large caps are less volatile and tend to weather recessions better. They are less exposed to changing interest rates. At present, after years of underperformance, they are also cheaper.”The key to the dual dynamic we’re seeing in both emerging markets and large-caps lies in the largest emerging markets, he says. MSCI’s Bric (Brazil, Russia, India and China) index is up almost 6 per cent from its peak before the credit squeeze. Valuations look very stretched. China’s Shanghai Composite, in particular, trades at a far higher multiple than the S&P.
With credit worries for the moment receding, the market’s faith in the secular growth story emanating from the largest emerging markets remains stronger than ever.
And this, in turn, explains the performance of large caps. “They have the greatest exposure to emerging markets and they benefit the most from the weak dollar”.
“Even with Chinese companies selling at more than 50 times their earnings, it appears that in the current environment, traders believe that a ‘flight to quality’ means investing in the Brics. Let’s hope they’re right.”
