This commentary was written by Bill Witherell, Cumberland’s Chief Global Economist. He joined Cumberland after years of experience at he OECD in Paris.  his bio is found on Cumberland’s homepage, www.cumber.com. He can be reached at [email protected].

Last year’s series of disturbing shocks to the global economy and the willingness of global investors to take on risk particularly unkind to the equity markets of the so-called BRICs, the four largest emerging-market economies: Brazil, Russia, India and China. The combined equity markets of these four countries declined 24.85% over the year, as measured by the MSCI BRIC equity market index. The declines for the individual markets, as measured by their respective MSCI Indices, were as follows: Brazil -24.85%, Russia -20.95%, India -37.97%, and China -20.41%. Another very large emerging market, Indonesia, showed its resilience by strongly outperforming the BRICs, registering a 4.03% advance for the year. Thus far in 2012, however, equity market leadership has returned to the BRICs.

The ability of the Indonesian market to withstand both the global crisis of 2008 and last year’s turbulence is due largely to the size and strength of its domestic economy and its prudent economic policies. The economy grew by a very healthy 6.5% in 2011 and is expected to register 6+% advances again this year and in 2013. The foreign debt of Indonesia is less than 10% of its GDP and is declining. Exports accounted for only 26% of GDP last year, shielding the country from last year’s global slowdown (in comparison, for Taiwan exports were 74%). The ratings agencies Fitch in December and Moody’s in January restored Indonesia’s sovereign credit rating to investment-grade.

Despite the solid economic prospects, the Indonesian equity market has stalled in the current quarter, down 4.71% year-to-date (February 24th). The outflows of foreign investor funds have been significant. There have been several negative developments. Labor unrest has increased. The government’s siding with the workers led some foreign investors from South Korea and Japan to protest. Inflation pressures are a continuing concern, limiting the willingness of the central bank to follow other central banks in cutting interest rates and expanding liquidity.

The most likely cause of the laggardly equity-market performance, however, is the demanding valuations that resulted from last year’s dramatic outperformance. In 2011 the Indonesian market was one of the very few national markets offering positive returns to global investors. According to Credit Suisse, the current premium for Indonesian stocks, compared with other major emerging markets, is almost 50%. The difference in P/E ratios for country ETFs is substantial. For the Market Vectors Indonesian Index ETF, EPI, the P/E is 14.06. This compares with 8.73 for the SPDR S&P China ETF, GXC; 8.9 for the Wisdomtree India Earnings ETF, EPI; and 7.11 for the iShares MSCI Brazil Index ETF, EWZ. While some of the premium for Indonesian stocks is justified, current valuations do look to us to be too rich.

In contrast, the BRIC equity markets have outperformed in the opening two months of 2012, as investor confidence in the global economic recovery strengthened on the back of dramatic central bank action to pump more liquidity into credit markets, record low interest rates, and rising oil prices. As a group the BRIC equity markets are up 20.92%, regaining a good part of their 2011 losses. The largest increase has been the 27.57% advance of the India market, which declined the most last year. The Indian economy looks likely to continue to advance at 7+% rates this year and the next. Brazil’s market is up 21.37% year-to-date, as economic growth shows signs of accelerating. The Chinese equity market also is doing much better, advancing by 16.55% year-to-date, just about the same as the 16.5% increase for the comprehensive Emerging Markets EEM benchmark. The Chinese economy appears to be achieving a “soft landing,” as authorities are engaged in reversing their formerly restrictive policies and seeking to loosen up the tight interbank liquidity situation. A week ago the People’s Bank of China (the central bank) announced a 50-basis-point reduction in the required reserve ratio for banks.

The fourth BRIC equity market, that of Russia, also has been recovering, gaining 25.69% year-to-date. The economy is doing well, riding on the strength of higher oil prices. It seems evident that Putin will take office again in March. He may well respond to demands and make some needed reforms, but the resistance from vested interests and the bureaucracy will limit their scope. We continue to be uneasy about investing in a Putin-led Russia and want to see significant improvements in governance first.