Is Risk In Emerging Economies Less Than Developed Economies?

by: Prieur du Plessis

To get an overall view of the health of emerging-market economies I developed a GDP-weighted manufacturing PMI as well as a GDP-weighted non-manufacturing/services PMI index using 2010’s GDP converted to U.S. dollars.

Following a double-dip in September and November last year, growth in manufacturing is steadily increasing, with the manufacturing PMI in February rising to 52.0. The PMI is still significantly below the recent peak of 54.3 in January last year.

(Click charts to expand)

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

In the first half of last year growth in the manufacturing sector of emerging economies was significantly slower than that of the major developed economies. The sovereign debt crisis in the eurozone leveled the score in the second half, though.

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Sources: Markit; HSBC; CFLP; Kagiso; ISM; Plexus Asset Management.

With a weight of 51.9% China’s manufacturing sector has a major bearing on the emerging economies’ manufacturing PMI. Nowadays it is popular to say that when China sneezes the other the emerging-market economies catch a cold – yes, the same adage used for the U.S. in the past. My analysis indicates it is devoid of any truth. It is evident that the trend of my cyclically adjusted China CFLP Manufacturing PMI is out of sync with the GDP-weighted Manufacturing PMI of the emerging economies excluding China. The gradual weakening of China’s PMI from October 2010 to February 2011 had no effect on the rest of the emerging economies as the latter’s PMI continued to rise until Japan’s terrible twin disasters in March. The Manufacturing PMI (excluding China) bottomed in September last year while China’s PMI only bottomed in November, but the two series are now rising in unison.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

The GDP-weighted PMI (excluding China) is highly correlated with the GDP-weighted Manufacturing PMI that I calculate for the major developed economies.

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Sources: Markit; HSBC; CFLP; Kagiso; ISM; Plexus Asset Management.

Due to limited data, I was forced to focus on the BRIC countries when calculating the non-manufacturing/services PMI for emerging economies. Contrary to the manufacturing PMI the non-manufacturing/services PMI of the BRICs remained well above 50 at the height of the eurozone crisis and in February regained pre-crisis levels.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

It is noteworthy that while the services sector in the developed economies collectively was severely affected by Japan’s twin disasters the services sector in the BRIC zone was largely unaffected. It was only when the eurozone crisis deepened that significant weakness appeared in the BRIC services sector. This sector also led the recovery as the crisis started to dissipate.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

China’s non-manufacturing sector that comprises 44.7% of the BRIC zone’s non-manufacturing/services PMI initially held up extremely well relative to the other BRIC economies when the eurozone crisis hit the headlines, but in the end succumbed when the crisis deepened. The drop in China’s PMI in February last year can be ascribed to the later than normal Chinese Lunar New Year.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

It is also interesting to note that growth in the services sector of the BRIC zone is very steady compared with that of the developed economies – even with the stalwart China excluded.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

Although the country’s weight is only 3.4%, I included South Africa in the calculation of a GDP-weighted composite PMI (manufacturing and services combined) for emerging economies as represented by the BRICS zone (BRIC plus South Africa).

The BRICS Composite PMI recovered sharply to 55.5 in February after nearly stalling in November last year.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

The composite PMI of BRICS remained relatively steady in the aftermath of Japan’s twin disasters but eventually gave way as the eurozone crisis deepened.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

Again China’s dominance in the composite PMI had a major impact as it is noteworthy that the BRICS Composite PMI excluding China bottomed in September while China’s PMI only bottomed two months later.

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Sources: Markit; HSBC; CFLP; Kagiso; Plexus Asset Management.

I asked myself whether relative strength in the BRICS composite PMI relative to developed economies matters in the relative performance of the emerging-market equity indices against mature-market equity indices.

There is clear evidence that China’s stock market’s performance relative to the MSCI World Index in terms of U.S. dollar is in fact heavily influenced by the performance of the underlying economy relative to the global economy as measured by relative composite PMIs. The derating of China’s stock market relative to global stock markets in the second quarter of last year stands out. Over the past three months the Chinese market has made up some lost ground but significant relative upside potential remains.

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Sources: Markit; HSBC; CFLP; Kagiso; I-Net Bridge; Plexus Asset Management.

My research indicates that the underlying economy of India as measured by the composite PMI has no bearing on the relative performance of the Indian stock market. The relative performance of China’s economy has a huge impact, though.

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Sources: Markit; HSBC; CFLP; Kagiso; I-Net Bridge; Plexus Asset Management.

As in the case of India the underlying economy of Brazil as measured by the composite PMI has no bearing on the relative performance of the Indian stock market. What I found is that the Brazilian stock market’s performance relative to global stock markets is highly correlated to the GDP-weighted Emerging Economies’ manufacturing PMI.

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Sources: Markit; HSBC; CFLP; Kagiso; I-Net Bridge; Plexus Asset Management.

In Russia’s case the relative performance of the stock market is primarily influenced by oil prices and not the state of the underlying economy as measured by the composite PMI relative to the global economy.

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Sources: I-Net Bridge; Plexus Asset Management.

The relative performance of the South Africa’s economy also has no bearing on the stock market’s performance. Metal prices are the main determinants.

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Sources: I-Net Bridge; Plexus Asset Management.

In conclusion, the emerging economies are not as dependent on China as many would like to believe. In light of the steadiness of especially the non-manufacturing/services composite PMI of BRICs relative to that of the JP Morgan Global Services PMI I am of the opinion the economic risk in emerging economies is less than that of developed economies. Do emerging markets then not deserve better ratings and more exposure in global diversified portfolios? It is clear to me that different factors influence the relative performance of the individual emerging markets and they are therefore not a homogenous group.