Ramblings of a Portfolio Manager 5-18-2009

Ramblings of a Portfolio Manager or How "Cowboys and Indians" Became an Investment Strategy

As we write this, the Bombay Stock Exchange is halted from yesterday 40 minutes into trading with the Sensex, the proxy index for the Indian Stock Market, up 17%. Over the weekend India held elections with the incumbent ruling coalition remaining in power and gaining seats in Parliament at the expense of the rival Communist party. The decisive victory raised optimism that a strong coalition would be able to push through economic reforms, which would boost the domestic economy and foreign investment. The Sensex is now up 77.5% from its March low and 48% year to date and the Rupee is at a 5-month high. With China’s Shanghai index up 45% year to date, the so called “Chindia” trade has far outpaced the US stock market averages, the best of which, the NASDAQ, is up a “mere” 12.4% in comparison.

Arbitrage opportunity or reason for concern? With the world’s two largest emerging markets outperforming the US stock indices one needs to question why: Markets are discounting mechanisms and what they discount is the future direction of their respective underlying economies. Since the US consumer has traditionally been the largest market for the exports of these two countries, how can their economies prosper without a corresponding recovery in ours? Are the markets saying, then, that China and India will emerge from this global recession ahead of the US or without it? Or are they just plain wrong? Conversely, are they pointing to a recovery in our economy that US portfolio managers just don’t see? We tend to favor the latter explanation.

The global economic picture has become more of a two-way street over the last decade meaning that the US, China and India are more co-dependant than ever before. So if their respective stock markets are correct, then our largest emerging market trading partners may, for the first time, “help” us out of our economic difficulties. Yet despite the significant rally since March 6, many US portfolio and hedge fund managers remain “underinvested.” Which means that, if the emerging markets are correct, our little recent run-up, which many have dismissed as only a bear market rally, could have legs still.