Thursday, June 28, 2007

Reweighting On Emerging Markets

There appears to be a growing shift in asset allocation for emerging markets and Asian equities for the second half of 2007. The trend is a recommendation to lower exposure to USD denominated emerging markets sovereign bonds. Probably based on a fear of some emerging markets potential downside on probable higher risk aversion mentality in the near future. While they are still bullish on emerging markets equities, some have scaled back the overweight to just slightly above the benchmark levels. That is to be expected as emerging markets have been performing very well, and it would be prudent to lock up some gains.

Some strategists are worried over the the impact of the sharp rise in global bond yields on the ex-ante equity risk premium of MSCI Emerging Markets over 10-year US Treasuries. The rise in 10-yr US Treasuries bond yields to 5.00%-5.20%, together with recent gains in the MSCI Emerging Markets price index, has compressed the equity risk premium to just 344 basis points currently. This is the lowest level since 2001 and is now within 150 basis points of the levels associated with the major MSCI Emerging Markets' peaks of 1997 and 2000.

For the second half of the year, countries getting promoted include: Japan, South Korea, Taiwan, Russia and Brazil. Countries which saw a reduction in weightings include: Malaysia, China, India and South Africa.

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