Emerging Markets Leading the Recovery

In the wake of the financial crisis, the "decoupling" theory—that emerging markets could continue to grow with developed economies in the grip of severe recession—was dismissed. Now, with (1) the MSCI Emerging Markets Index up an impressive 38% year-to-date, versus single-digit re­turns for the S&P 500 and the MSCI EAFE Index (foreign developed mar­kets), and (2) certain emerging stock markets (i.e., China) back to levels prior to the collapse of Wall Street finance last September, the "decoupling" theory is back in vogue. There is an obvious element of truth to the theory, given the more favor­able growth and demographic charac­teristics of key emerging markets, but clearly these economies are inter­twined with the global economy, including the developed markets that still comprise a majority of global GDP. The recent strength of their stock markets suggests that the global economy is recovering.

Corporate Bond Spreads Continue To Normalize

Equity and commodity markets have recently confirmed that the depression is over, but credit markets have shown steady improvement since the fourth quarter of 2008, when the Fed began to apply its unprecedented support meas­ures. Short-term commercial paper and inter-bank lending markets were the first to recover. Three-month U.S. dollar LIBOR (the inter-bank lending rate) is at a post-crisis low of 0.65%, after having been as high as 4.8% last October. Corporate borrowing rates have declined steadily since late 2008, when the yields on corporate bonds rated Baa (the lower end of investment grade) implied default rates worse than those of the Great Depression! In the past six months, the spread between long-term Treasuries and long-term Baa-rated corporate bonds has nar­rowed from over 5.5% to 3.5% (see chart below), a level that is more typical of a merely recessionary environment, rather than a depression. Municipal bond yields have shown a similar improvement, and are back to more normal relationships to federal government bond yields.

Spread (in basis points)

Global Stock Market Valuations

Broad Stock Market Index Valuation Analysis

Notes:

Blue horizontal lines represent averate price-to-book multiples over the period.

Red horizontal lines represent 25th and 75th percentile price-to-book multiples over the period.

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