It's all about Risk Aversion

The received wisdom says that the current sell-off in the stockmarkets is the result of rising risk aversion. Rising risk-aversion should mean that emerging markets, which are perceived as more risky assets, should underperform compared to the developed markets. Has that happened? Not really. Till 5 June, the MSCI World Index showed a drop of 3.915 per cent for the quarter to date, that is between 1 April and 5 June. Over the same period, the MSCI Emerging Markets index was down 2.941 per cent, less than the World Index. Similarly, the MSCI BRIC index was down only 2.033 per cent. In other words, emerging markets have not fallen as much as the other indices.

Now, consider the individual MSCI indices. It’s true that MSCI

India was down a huge 9.753 per cent over the period but the MSCI indices for Indonesia and the Philippines are in positive territory. Among developed markets, the MSCI US index was down only 2.356 per cent for the quarter. But MSCI Japan is in the red by 7.246 per cent for the quarter and MSCI France is down 5.617 per cent. In short, the data does not support the notion of emerging markets being sold off more than the other markets.

Have the markets with the highest valuations been worst hit? It would, after all, make sense to sell off the most expensive stocks. On the basis of 2007 earnings, India’s PE with the Sensex at 10,000 is around 14.7. That still makes it much more expensive than emerging markets’ 2007 PE of around 12 or Asia (ex-Japan) 2007 PE of 12.6 or so. Among the major markets only Japan has a higher PE, which explains the big drop in the Nikkei.

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