Changing axis

Emerging markets are outperforming the US, both in terms of returns and fund flows

One major theme of investing in emerging markets is speculating when they will have the strength to decouple from the US market. Investments in emerging markets have usually been made when the US market too is doing well.

At the most basic level, the correlation is seen when market watchers in India look at how the US markets performed before making their predictions for the day's trading.

With the barriers to capital mobility coming down, it's rather obvious that markets will become increasingly global.

However, if we take the data for the past five years, it appears at first sight as if the Indian market and, to a lesser extent, the emerging markets universe have already decoupled from the US.

The MSCI index for the US, for instance, has fallen by 20.9 per cent between August 31, 2000 and August 19, 2005. Over the same five years, the MSCI index for India has gone up by 61.6 per cent, while that for emerging markets as a whole has moved up by 43.1 per cent.

For the five years as a whole, therefore, it certainly looks as if India has gone in an opposite direction to the US.

That goes against common sense, however, and a closer scrutiny unveils the flaws in that argument. During August 31, 2000 to December 31, 2002, for instance, all markets fell in tandem - the US MSCI index lost 43.2 per cent, the MSCI India index was down 24.1 per cent, while the MSCI emerging market index lost 21.6 per cent.

Between December 31, 2002 and August 19, 2005, the MSCI US index moved up by 39.3 per cent, the emerging market index was up by 82.5 per cent, while the India index rose 112.89 per cent.

Rather than show decoupling between the markets, the data point to the following conclusions: a) the US markets lost far more than emerging markets during the downturn from 2000 to 2002, b) the bull run has been far more pronounced in emerging markets compared with the US, and c) the Indian market has performed better than most emerging markets in the last two-and-a-half years.

While the decoupling story may be incorrect, at the very least, these conclusions are a pointer to the fact that emerging markets are increasingly becoming a stronger asset class.

That in turn reflects a change in global economic fundamentals wherein several emerging market economies have shown strong growth in recent years, and on global perceptions, where the potential of these economies are being increasingly recognised. That's also evident from the fund flows.

According to EmergingPortfolio.com Research, while the combined emerging market equity funds tracked by EPFR had cumulative inflows of $8.74 billion this year, US equity funds tracked by them had negative flows of $1.5 billion this year.

Titan Industries

Titan Industries is part of a rare club of stocks with price-earnings multiples in excess of 100 times. The watches and jewellery company now trades at 118 times consolidated earnings for FY05.

True, last year's profit was hit by a large write-off relating to the company's European operations (45 per cent of pre-tax profit), but even based on analysts' bullish expectations for FY06, the stock trades at about 35 times forward earnings.

Titan Industries has seen a sharp turnaround in its performance since FY04 - its operating profit has risen sharply by over 100 per cent both in FY04 and FY05.

Much of the re-rating in the stock, however, has happened in the past year, during which the stock jumped 280 per cent. In the one year before that, the stock had gained by a much lower 70 per cent.

The current enthusiasm in the stock suggests that the markets expect high growth to continue for some time to come. The core watches and jewellery businesses are expected to grow at a steady pace, while the relatively new precision engineering business could be a growth driver, what with the company expected an average annual growth of 70 per cent over four to five years.

But given the high valuations, investors would do well to factor in some concerns stated by the company in its annual report, "Watch, as a product category, is facing the threat of losing sheen in its functional value and could be stagnating in the long term with increasing penetration of mobile phone and hi-tech products." It further states that the grey markethinese invasion is a challenge in the lower end of the market, which means that remaining cost competitive is imperative.

On the other hand, increasing brand spends is inevitable for the other segments, the report adds. Even in the international segment, margins are getting squeezed owing to competition from global players in each market segment. The risks to the watch segment are worth noting since they account for over 82 per cent of total segment profit.

With contributions from Mobis Philipose