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MSCI World Erases Lehman Slower Than Emerging Markets

U.S. Federal Reserve Chairman Ben S. Bernanke
As confidence in the U.S. and European economies waned, Fed Chairman Ben S. Bernanke suggested four months ago that he might purchase bonds, triggering a global equity rally and speculation that he will reignite inflation. Photographer: Tomohiro Ohsumi/Bloomberg

Stocks in developed nations took 17 months longer than emerging markets to erase losses spurred by Lehman Brothers Holdings Inc.’s 2008 bankruptcy, recovering after the Federal Reserve took steps to stimulate growth.

The MSCI World Index of 1,660 companies in 24 developed countries such as the U.S., U.K. and Japan rose as high as 1,283.68 yesterday. The gauge surpassed its closing level of 1,283.14 on Sept. 12, 2008, the last session before Lehman’s collapse caused a 46 percent drop through March 2009.

Developed nations are lagging behind the 21-country MSCI Emerging Markets Index, which finished its recovery in August 2009 and rallied another 31 percent after stocks from Brazil to Turkey advanced amid faster growth. As confidence in the U.S. and European economies waned, Fed Chairman Ben S. Bernanke suggested four months ago that he might purchase bonds, triggering a global equity rally.

The “new economic leadership is reflected by emerging market stocks, which recovered to pre-Lehman levels much faster than have developed stock markets,” said James Paulsen, chief investment strategist at Minneapolis-based Wells Capital Management, which oversees about $340 billion. “Economic activity in these regions did not slow or contract as deeply and have recovered much faster.”

Emerging Market Expansion

Emerging economies may expand 6.4 percent in 2011, almost three times the 2.2 percent rate for developed nations, according to the International Monetary Fund. Government debt will probably amount to 37 percent of emerging-market gross domestic product next year and budget deficits will be 2.9 percent, compared with levels of 101 percent and 6.7 percent in advanced nations, the Washington-based fund predicts.

The MSCI World Index surged 86 percent through yesterday since sinking to a 12-year low of 688.64 in March 2009. Stocks have rallied around the world as central banks kept interest rates near record lows while governments spent trillions of dollars to spur growth, boosting confidence in the global economy and helping equity markets overcome the worst financial crisis since the 1930s.

“We were priced for the end of the world until mid-March 2009,” said Komal Sri-Kumar, who helps manage $111 billion as chief global strategist at TCW Group Inc. in Los Angeles. “So when Armageddon didn’t happen, we had a significant jump from the lows. Add to this massive fiscal and monetary stimulus, the continued healthy growth in emerging markets and Bernanke’s quantitative easing speech at the end of August.”

Quantitative Expansion

The MSCI World Index fell 0.2 percent to 1,276.69 as of 4:30 p.m. in New York today after the highest valuation for the Standard & Poor’s 500 Index since June helped drag down U.S. shares. The MSCI Emerging Markets rose 0.8 percent to 1,145.79, its third straight gain, as Chinese manufacturing expanded.

The S&P 500 surged 20 percent through yesterday since Bernanke’s Aug. 27 speech in Jackson Hole, Wyoming, where he foreshadowed the second round of quantitative easing. The central bank said in November it will buy an additional $600 billion of bonds through June, expanding on record stimulus of $1.7 trillion in asset purchases. The S&P 500 erased its loss on Dec. 21.

The Stoxx Europe 600 Index, a gauge of stock markets in the region, tumbled as much as 15 percent from its 2010 peak in April amid concern that Europe’s government-debt crisis could derail the economic recovery. The region’s leaders were forced by Greece’s financial crisis to provide 860 billion euros ($1.1 trillion) in emergency support in May.

European Recession

The European Central Bank cut its rate to 1 percent in May 2009 to fight the worst recession in its history. A year later the central bank began buying government bonds for the first time to ease credit-market tensions as investors focused on growing budget deficits. As recently as this month, the ECB was forced to delay a further withdrawal of unlimited liquidity support to euro-area banks.

“The recovery was built on a foundation of trillions in combined fiscal and monetary stimulus,” said Rob Arnott, founder of Research Affiliates LLC, which oversees about $61 billion in Newport Beach, California. “All that money has been pouring into an economy that is reluctant to absorb it because of uncertainty over future regulations and investments, so it has been parked in capital markets.”

The MSCI World Index must rise more than 30 percent to exceed its record high in October 2007, when markets rallied as the U.S. economy expanded at the fastest pace in a year and a half and the Fed cut its target overnight lending rate to prevent a recession. A contraction began in December 2007 and ended in June 2009, according to the National Bureau of Economic Research in Cambridge, Massachusetts.

Israel, Sweden

Israel’s TA-25 Index, which MSCI Inc. shifted to developed-market from emerging-market status in May, is the best performing measure among nations in the MSCI World Index. It has surged 41 percent since September 2008 as.

Sweden’s OMX Stockholm 30 Index has rallied 37 percent since Lehman’s bankruptcy for the second-best performance among developed markets. The combination of surging exports and Europe’s smallest deficits boosted optimism for Nordic markets.

Hong Kong’s Hang Seng Index, whose 19 percent gain is fifth-best, reached a 31-month high on Nov. 8 amid rising domestic property prices and reports that showed China’s economy gaining momentum. The gauge has gained 5 percent this year, after rallying 52 percent in 2009, on speculation growth in corporate profits would counter China’s steps to curb property-price inflation.

‘Sub-Par Recovery’

“We have settled into a sustainable but still sub-par recovery by historical standards,” said David Joy, chief market strategist at Columbia Management in Boston, which oversees $327 billion. “Clearly the developed markets will trail the emerging markets because they simply didn’t have the same degree of downturn and strains on their financial systems as we did.”

Greece, which was forced into a bailout from the European Union and the International Monetary Fund, and Ireland have the worst performances among countries in the MSCI World Index since the beginning of the financial crisis. Greece’s benchmark stock index, the ASE Index, is down 54 percent since September 2008 while Ireland’s ISEQ Overall Index has lost 34 percent.

Financial stocks have lost 20 percent as a group since Lehman’s failure, the most among 10 industries, led by an 89 percent slump in Dublin-based Bank of Ireland Plc. Lenders were dragged down by $1.7 trillion of global bank losses and writedowns tied to property loans during the credit crisis that began with mortgage defaults and accelerated with the collapse of New York-based Lehman in 2008.

Netflix, SJM Holdings

Companies reliant on consumers’ discretionary spending -- including Los Gatos, California-based Netflix Inc. and Hong Kong-based SJM Holdings Ltd., Asia’s biggest listed casino operator -- recovered their pre-Lehman level on March 12 and the group of 245 companies has surged 18 percent since then, the most among 10 industries in the MSCI World Index.

“The best way to play to the deepest consumer recession in 70 years as an active equity manager was to buy the consumer discretionary stocks,” said Doug Ramsey, Leuthold Group LLC’s director of research in Minneapolis. “Consumer stocks had already underperformed going into the Lehman event. It was a classic case of when strategists finally got their head around the economic trends to coin fancy terms like new normal and the frugal future, it was already over and it was time to go the other way.”

Old Recovery

Pacific Investment Management Co., which oversees the world’s biggest bond mutual fund, said in May 2009, one month before end of the U.S. recession, that rising government deficits and regulation would hold gains in equities and bonds below historical averages. Mohamed El-Erian, Pimco’s co-chief investment officer, said in an e-mail on Dec. 1 that the forecast has a 55 percent to 60 percent chance of coming true.

The global market recovery was established months ago, according to Arnott, who uses fundamental indexing to invest, giving weight to sales, net worth, earnings and dividends to determine what proportion of an index’s value each stock should represent.

Arnott’s FTSE RAFI US 1000 Index, the 1000 largest companies in the US weighted by company size rather than market capitalization and assembled by S&P competitor FTSE Group, recouped all of the post-Lehman losses by Jan. 5. Companies in the MSCI World Index are weighted according to market value.

“The recovery is now very old news,” Arnott said. “The big story about the recovery of the post-Lehman damage is not that we seem poised to recoup the loss, it’s that these indexes took way longer than they needed to do so.”

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