The strong run in emerging market equities and the relative outperformance of non-US developed market stocks appears to have ended as a weak US housing market weighs down on consumers and credit markets and high commodity prices stoke inflation worldwide.
In fact, the S&P 500 index has actually outperformed both the MSCI EAFE and main emerging market indices since year to date.
European and Japanese stocks, which have done relatively better that US stocks for some time, are suffering both from weaknesses in US consumer demand and the depreciating dollar and from tighter credit conditions and commodity prices at home. Although valuations are attractive, the macroeconomic headwinds are giving investors no reason to break out into a new direction and buy with confidence.
Stocks in emerging markets, by contrast, are being hit mainly by rising inflation, as economic growth remains strong in absolute terms thanks to the continued strength of domestic demand.
"What’s really hurting emerging markets this year is rising inflation," says Alec Young, international equity strategist at Standard & Poor’s Equity Research. "We recommend underweighting emerging Asia, China and India as these markets have the highest valuations in the emerging market universe and are also the most vulnerable to higher inflation and rising interest rates."