3 Market Calls: Neutral On Indonesia, Overweight Taiwan, VIX Closer To Fair Value

by: Russ Koesterich, CFA

Call #1: Neutral on Indonesia

I first advocated an overweight view of Indonesia back in early February. Since then, the market has bucked the negative global trend. Since February, the iShares MSCI Indonesia Investable Market Index Fund (NYSEARCA:EIDO) has gained roughly 9% and has outperformed the MSCI Emerging Markets Index by 25%. Indonesian equities currently trade at 3.6x book value, more than twice the emerging market average. Past performance does not guarantee future results. For standardized performance for EIDO, please click here.

Given the magnitude of this outperformance, Indonesia no longer looks that cheap relative to other emerging markets. As such, I’m closing out my overweight view on the country, and I am moving to a neutral stance.

Call #2: Overweight on Taiwan

I’m seeing better opportunities in other parts of Southeast Asia, particularly in Taiwan.

Equities in Taiwan are also trading at a premium to other emerging markets, but the premium is modest and is justified given Taiwan’s above average growth prospects. Taiwan’s gross domestic product is expected to grow by 5% in both 2011 and 2012. Among other reasons to like Taiwan, the country’s corporate sector is profitable with a return on assets of 11.2%, well above the global average. Taiwan’s dividend yield of roughly 4.5% is also well above the global average.

But the Taiwanese market is not without risks. Its biggest risk: Taiwan is an export driven economy. If the global economy experiences a double dip, Taiwan will suffer. Still, I believe investors are being compensated for the risk (possible iShares solution: EWT).

Call #3: Market Volatility Level is Closer to Fair Value

Finally, I want to provide an update on my view of market volatility. In mid-August, I suggested that market volatility levels appeared extreme. At the time, the VIX — or volatility index — was trading in the mid 40s, more than double its long-term average.

While I expected a difficult and volatile market environment, my analysis suggested that investors were overreacting. Volatility was higher than it should be and was likely to fall. Since then, the average level of the VIX Index has been in the mid 30s. It closed Thursday at around 30. This level is still elevated relative to the index’s long-term average, but it’s closer to fair value. As such, I’m no longer a seller of market volatility. Going forward, assuming that Europe can address its immediate problem and that there is no disorderly default by Greece, I expect equity market volatility to remain in the mid 20s to low 30s for the foreseeable future.

Source: Bloomberg

Disclaimer: The performance quoted represents past performance and does not guarantee future results. Investment return and principal value of an investment will fluctuate so that an investor’s shares, when sold or redeemed, may be worth more or less than the original cost. Current performance may be lower or higher than the performance quoted. Performance data current to the most recent month end may be obtained by calling toll-free 1-800-iShares (1-800-474-2737) or by visiting www.iShares.com.

In addition to the normal risks associated with investing, international investments may involve risk of capital loss from unfavorable fluctuation in currency values, from differences in generally accepted accounting principles or from economic or political instability in other nations. Emerging markets involve heightened risks related to the same factors as well as increased volatility and lower trading volume. Securities focusing on a single country may be subject to higher volatility.

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