Emerging Markets on a Tear

I thought by now investors would know better not to decipher minutes of the Federal Open Market Committee (FOMC) meetings each time they are released. Maybe I don’t really understand English, but there is never a clear giveaway to bulls or bears in these minutes.

But some investors continue to react feverishly. Were it not for a sell-off soon after the minutes emerged today the indices were on course to match or even top yesterday’s gains, based on the prevailing “soft landing” in 07 scenario reinforced by the economic data released so far this week.

Nevertheless, buyers outnumber sellers to take the indices higher on strong volume support. The consolidated number of shares that change hands reaches almost 5 billion, similar to yesterday’s tally. Based on the volume over the past two days there is definitely widespread support on Wall Street for the current market rally. It is by no means losing steam.

From all indications the US economy – as measured by Gross Domestic Product (GDP) - is poised to slow down in 07 to a level in the 2% - 2.4% range versus 2.5% - 3% forecast for this year. Meanwhile Europe, and even slow motion Japan, is forecast to grow faster than the US in 07. But emerging markets (EMs) will be in a league of their own. This must be one reason why EEM has posted gains each session since last Wednesday.

According to the World Bank many EMs will next year grow between 4% and 6%, with outliers like India - 7% and China - 10%. To be sure, EMs have grown faster than mature markets – US, Europe and Japan - for a long time now but these days many US companies with international operations now derive a higher proportion of their revenues from EMs. When PG reported its FY2007 first quarter results last month, revenue from non-US operations topped 50% for the first time in the firm’s history. This is a growing trend amongst US large caps.

What does this all mean? I believe against next year some rotation into EMs or US firms with large non-US operations is called for. The manager never invests in large caps without exposure overseas – this is why I picked COST over Target - but this week I increased my direct positions in “foreign” stocks from 28% to 30% - EFA down to 21% from 22%; EEM up to 9% from 6%. It is likely to remain 30% through next year. The US may sneeze in 2007 but the rest of the world won’t catch a cold.