The markets react as the Dow Jones recorded its largest one-day points fall in history last month

    The markets react as the Dow Jones recorded its largest one-day points fall in history last month

    Back to frontiers

    3 March 2018

    There are several mantras that experienced investors use to guide themselves through the markets. ‘Sell in May and go away’ is one of the best known. ‘It’s a stock-pickers market’ is another. But perhaps the most effective is ‘Right way first’. Effectively, it means that whatever the main indices do in the first couple of weeks of the year will tell you about how that year will unfold. It works more often than you might imagine. To take the S&P500, still the most important global index, as an example, it has risen by 5 per cent or more in January in 12 years since 1950. And in all of those years, the index was up over the year, and often substantially so.

    So what did we learn from January this year? Most obviously that 2018 is going to be a good year for stocks. The wobble of early February, which admittedly saw the biggest one-day points fall on the Dow ever, should according to this analysis be nothing more than a blip. The S&P came roaring out of the blocks, and ended the month 5.8 per cent ahead. But we learned something else as well — that the out-of-favour emerging and frontier markets are likely to come storming back. In the first week of the year, the MSCI emerging markets index rose by 3.4 per cent, its best start to the year since 2006. In some individual markets the gains were even more impressive. The best performing market in the first two weeks of January was Nigeria, up by 17 per cent in a fortnight. It was followed by Argentina, Qatar, Russia and Romania, all up by between 8 per cent and 11 per cent in a fortnight. The only major developed market in the top ten was, surprisingly Italy, up by 7.6 per cent. And of the Top 20 best performing markets over January, only three were developed.

    Can that last? For most of the bull run that started in 2009, the emerging and frontier markets have all lagged their developed peers. Over the course of the past 12 months, they started to recover, with 30 per cent-plus gains during 2017. But a lot of the excitement in the stock market has been in technology companies, mostly in the United States. It has been the FANGS that have captured the imagination of investors far more than the BRICs or the MINTs (that, in case you aren’t up on your market acronyms, is ‘Facebook, Amazon, Netflix and Google’, ‘Brazil, Russia, India and China’ and ‘Mexico, Indonesia, Nigeria and Turkey’). The real growth has come from a select group of companies that are disrupting traditional industries, not from new nations climbing up the income ladder.

    There are, however, four big reasons for thinking that might be about to change this year. First, global trade is finally starting to revive. After falling off a cliff during the financial crash of 2008/09, the amount of stuff being moved around the world is rising again. In 2017, it was up by 4.2 per cent, the first time trade had outpaced global growth since 2014. Shipping rates have started to rise again as container vessels fill up. We may not feel it in this country, where growth has been very tepid, but in Europe and the US economies are performing strongly and consumers are spending money again. That is important for a simple reason. It is the develop-ing world that is most dependent on trade, and especially exports to Europe and North America. As people spend more money in the shops there, factories will be a lot busier in Turkey and Vietnam, and those economies will see the kind of boost that turbo-charges growth.

    Next, commodity prices are starting to recover, led mainly by oil. At $65 a barrel, oil is at a three-year high, and it has risen by close on 50 per cent in the past year alone. That single statistic explains the performance of markets such as Russia and Nigeria, two of the big gainers in the first month of this year. But it is not just that. The copper price is hitting four-year highs. Industrial metals are up by 24 per cent in the past year, and as factories churn out more stuff to meet reviving global demand, they are likely to keep going up. Many of the frontier markets are heavily dependent on a single commodity. When that goes up in price, the entire economy gets a boost.

    Thirdly, reforms have, in some places at least, started to kick in. Argentina, the second-best performing market in the first weeks of the year has in Mauricio Macri a president who has finally started tackling its chaotic economy, scrapping tariffs, cutting taxes and ending currency controls.

    In South Africa, the ageing Jacob Zuma has finally been eased out of power, paving the way for a more business-friendly regime. In many frontier markets, economies are crushed by corrupt, chaotic dictators. It only takes a very modest improvement in the standards of government to have a big impact on the markets.

    Finally, most developed markets are getting punishingly expensive, and that means investors will quite rightly look elsewhere. Wall Street is still trading near all-time highs, so are most European markets, and even the FTSE has managed to climb past its 1999 peak, while Japan is getting back to levels last seen in the early 1990s. Stocks such as Amazon are trading on multiples of more than 500 times actual profits.

    By contrast, markets such as Nigeria, Argentina and Russia are among the cheapest in the world. It is hardly surprising that investors are wondering why they are paying a fortune for a tiny slice of a web retailer when they can pick up a fatter slice of a growing company in other parts of the world for a fraction of the cost.

    Trading in emerging and frontier markets is always volatile. A sudden rise in global interest rates could easily derail them, and so could President Trump’s threatened trade wars. Even so, the record clearly shows that the first two weeks’ trading of the year set the tone for the next 12 months — and on that basis, emerging markets will be where the action is in the years ahead.