Thursday, July 8, 2010

Returns and Risks Equity Markets Top-50 Countries - Situation per Jun30, 2010

Please find attached a colorful document (pdf file) with the returns and risks of the 50 largest equity markets that belong to the MSCI World or MSCI Emerging Markets Indices. Data are from the LMG Emerge GTAA Model. Although Argentina was recently removed from the MSCI Emerging Markets index my MSCI Barra we decided to leave that country in the list.

Countries are ranked on the basis of their 3 year annualized returns in US Dollars (column RET 3YR). The columns with 1 and 10 year returns are also annualized. Returns over the last quarter (RET 3m) are not. Greener colors indicate better return performance. Red indicates bad performance. We used an absolute ranking mechanism for returns with a return of 7 percent annualized as scaling point. This implies there there isn't much green going on when looking at the 3 and 10 year annualized return columns. This is indicative of stock markets going through an abysmal period. It is remarkable to see that some smaller Emerging Markets (Colombia, Indonesia, Peru, Thailand and Chile) formed the top-5. The bottom-5 indicates clearly that smaller European countries within the Euro zone are struggling. Three of the four BRIC nations did reasonably well: Brazil, India and China. Russia posted negative returns during the last 3 years, albeit that the Russian 10 year performance (14.04 percent annualized) was good.

When looking at risk we analyze 3 variables, namely 'Beta', 'Volatility' and 'Downside Risk'. 'Beta' is the market risk factor that analyzes the sensitivity of a specific market for changes in the MSCI World Index. The higher beta, the more sensitive a country's equity market is to global return and risk factors. Higher beta's are of course good in positive climates, but they are bad when markets shift into a more depressed state. 

Volatility (VOLA) is measured by the standard deviation of returns. The higher the volatility the more extreme market fluctuations can be. Both Beta and Volatility are derived using an estimation technique that is also used within the LMG Emerge Global Tactical Asset Allocation Model. Beta and Volatility estimates are based on an average of data over the last 36 months and available data since the start of our database (1994 or older, dependent on the country).

The last risk variable is Downside Risk. This variable is also taken from an algorithm in the LMG Emerge GTAA Model. It provides an estimate of the potential Value at Risk in extreme cases. The higher a value the more likely that investors can suffer large losses in a specific market.

It is clear that there is no free lunch. The Emerging Markets countries that topped the table in Return space do on average show above-average risks, as indicated by the dominance of orange/reddish colors in the top of the table. Remarkable: when looking at the bottom of the table we see that these worst performing countries do - on average - post above average risks too. They are therefore double underperformers, both in return and risk terms.

The traditional safe havens (green-colored in risk terms) can mainly be found in the middle zone of the table, with Switzerland doing slightly better than the USA and Japan. The UK did not really live up to its reputation as safe haven. And in the case of Germany we can actually ask ourselves the question if it is really a safe haven. The German market seems to be relatively sensitive to international factors with a beta of 1.232.

For completeness sake we added a column with Upside Potential estimates. I.e.: after answering ourselves the question what markets could loose in extreme negative years, it is also fair to ask what they could win in extremely good periods. However, investing is NOT gambling and a decent risk profile implies that an investor values downside risk protection of x percent more than he would appreciate a gain of the same amount. We did translate this into leaving the color of the upside potential column gray.

It is clear from the table that returns over the last 12 months were actually quite good. There was some recovery going on after the 2008-2009 Global Crisis. However, the overall picture is still bad with the last 10 years being one of the worst in stock market history. Notwithstanding the fact that Emerging Markets are doing a great job as new (partial) catalysts of Global Growth, we are within our GTAA model still relatively careful with an overall equity weight that is slightly below average. The Emerging Markets weight is a little bit above benchmark levels but this is compensated by an underweight in Developed Markets equities.


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