Emerging market outperformance is no bear market rally

Strong emerging market outperformance should not be dismissed as a bear market rally, says Bryan Collings, manager of the Ignis International HEXAM Global Emerging Markets Fund.

Collings believes the recent surge, which has seen the MSCI Global Emerging Markets index rise 37% since 2 March, marks the return of ‘rationality' to markets following the indiscriminate sell-offs and technical unwinds which hit emerging equities throughout 2008 and early 2009.

"Risk appetite is returning and markets are starting to recognise how compelling valuations are, how extensive the policy response has been, and how much cash is on the sidelines waiting to enter the markets", he says. "The number of sellers has been severely reduced - as has the number of short positions - which means that when investors come in, it makes a big difference. But this is not a bear market rally."

Collings, whose offshore fund has returned 21.2% year-to-date compared with the index rise of 9.7%, points out that many emerging market indices, such as Russia's RTS Index, would have to plunge vertiginously from current levels in order to test previous lows. This, he says, is clear evidence that recent outperformance cannot be regarded as a positive blip in an otherwise downward trend.

"Russia has performed very strongly but to call it a bear market rally the RTS would have to fall by around 100% to test its February 2009 low - that is simply not going to happen. The rouble is stabilising, the oil price is stable - and being upgraded - the fiscal deficit is in good shape and a massive stimulus program has been announced. Russian equities were priced irrationally and now the market is beginning to pay attention to the fundamentals."

Collings believes emerging markets in general have now resumed their secular trend to outperform developed market equities. Although he says the decoupling theory has been "something of a distraction" he does expect emerging markets to continue to become less dependent on exports to developed economies.

"Most consumers, governments and corporates in the developed markets are overleveraged and this will reduce the demand for overseas goods. In the next 10 years we will see exports make a much smaller contribution to emerging market GDP as developing market consumers spend their savings and domestic consumption begins to increase."

Collings believes there is also likely to be greater domestic equity market participation in emerging markets as savings-rich consumers gradually become retail investors - something that will help developing markets cope with international money flows and reduce price volatility, he believes. In the meantime, he expects volatility to continue to be pronounced as markets digest further negative economic data.

"There is still a lot of trauma to work through and volatility will remain fairly high, although it has reduced markedly since its peak in November 2008. However, I do not expect to hear anything in two months' time about emerging markets challenging their lows - we are well past that point now and investors who have not had their money in the market will have missed a lot of performance. The good news for them is that there is much more to come."