Beware When Bulgaria Leads

08/10/2009 9:09 am EST


Prieur du Plessis

Author, Investment Postcards from Cape Town

Global investors favored developed markets and emerging laggards last week, possible signs of a pullback in the offing, writes Prieur du Plessis of Investment Postcards from Cape Town.

Risky assets last week again marched higher [after] economic data supported the argument of a global economic recovery. A realization among investors that the economic transition from recession to recovery was gaining momentum resulted in many global stock markets and commodities scaling fresh peaks for the year.

Many commodities, such as crude oil, copper, aluminum, nickel, lead and zinc, hit their highest levels of the year, not to mention sugar recording a 28-year peak. “The financial crisis has been addressed, the commodity crisis has not,” warned Goldman Sachs (via the Financial Times), predicting that this year’s rise in prices was “just the beginning” of another rally that was “ultimately likely to be even more extreme” than those seen in the past. However, the Baltic Dry Index—a measure of freight rates for iron ore and bulk commodities that correlates very well with base metal indices—has broken technical support on the down side, and short-term weakness in metals prices looks likely, possibly as a result of the Chinese buying frenzy having come to an end.

While high-yielding commodity-linked and emerging-market currencies were in favor, the US greenback dropped to its weakest level since October before staging a rally on Friday after the announcement of the US employment data had pleased some traders. Government bonds (with the exception of emerging markets) again sold off as the bond vigilantes cottoned on to the improved economic outlook.

The MSCI World Index (+1.8%) and MSCI Emerging Markets Index (+1.1%) both made headway last week to take the year-to-date gains to +15.5% and an impressive +50.4%. The US and other markets extended their rallies to four straight weeks in most instances, although some weakness crept in among developing countries, such as China, India, Singapore, and Taiwan. It is also noteworthy that emerging markets underperformed developed markets for the first time since the beginning of May. Could this be a first sign of a retrenchment in risk appetite?

Stock market returns for the week ranged from top performers such as Bulgaria (+15.5%), Romania (+8.3%), Lithuania (+8.2%), Kazakhstan (+8.1%), Estonia (+8.0%), and the Czech Republic (+7.1%). These are all Eastern European countries playing catch-up as pundits came to the conclusion that the initial doomsday scenario for the region’s debt situation was not as bad as predicted. At the bottom end of the performance ranking, countries included Malta (‑5.8%), China (-4.4%), Singapore (-4.1%), Côte d’Ivoire (-3.9%), Greece (‑3.6%) and India (-3.3%).

After almost doubling since the beginning of the year and notching seven straight weeks of gains, the Chinese Shanghai Composite Index declined by 4.4% last week—its worst performance for five weeks. The index has broken its first level of support, and it would not come as a surprise if lower Chinese equities serve as the catalyst for a pullback in global stock markets.

Of the 96 stock markets I keep on my radar screen, 74% recorded gains [last week], 21% showed losses, and 5% remained unchanged. As far as mature markets are concerned, 76% are trading more than two standard deviations above their 50-day averages and 56% more than two standard deviations above their 200-day lines.

Among emerging markets, 59% are trading more than two standard deviations above their 50-day averages and 68% more than two standard deviations above their 200-day lines. These figures argue that some degree of reversion to mean is probably overdue. This could take the form of either a pullback or a consolidation pattern.

For the fist time since mid-1999, emerging Asian stocks are trading at a premium of more than 35% to the 200-day moving average. This represents an overbought situation that is clearly not sustainable.

I am of the opinion that stock markets have run away from fundamental reality and that a pullback/consolidation looks likely. Taking a slightly longer-term view, I think we are in a (possibly lengthy) bottoming-out phase as far as slow-growth (OECD) countries are concerned, but already in new (potentially volatile) up trends regarding high-growth emerging and commodities-related markets. Caution seems to be in order.

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