From the July 2008 issue of Wealth Manager Web • Subscribe!

A 12-month review of the capital markets suggests declining dollar helped emerging markets surge.

Upon examination of the global capital markets over the last year, it should come as no surprise that the two best performing asset classes are outside of the U.S. markets. In fact, the emerging equity markets nearly doubled the total return of the next best performing asset class, international fixed income. The Russell Emerging Markets Large Cap Index was up 26.4 percent over the 12 months ending April 30, while the Lehman Global Aggregate ex-U.S. Index was up 14.8 percent for the same period.

Despite the turmoil in our domestic markets during the second half of 2007, the emerging markets continued to forge ahead, led for the most part by the energy, commodity and natural resources companies that make up significant portions of those markets-particularly in Latin America. This robust 12-month ranking is somewhat misleading however, as double digit returns in both the second (15.1 percent) and third quarters (14.8 percent) drove all the gains for the period. Since the end of the third quarter, the index has been roughly flat-despite an 8.3 percent return in April.

Since the end of the U.S. bear market in 2002, the emerging equity markets have been on a tear-even relative to the best performing domestic asset classes. For the five-year period ending April 30, 2008, the Russell Emerging Markets Index was up an annualized 35.5 percent per year. The top performing domestic equity asset class over that same period- represented by the Russell Midcap Index-had 18.2 percent-over half the annual return. However, portfolio strategists find it highly unlikely that this level of performance will be sustained in the near future.

While the emerging markets have certainly enjoyed a fundamentally sound rally for most of the last five years, a large portion of the returns over the last 12 months is tied directly to the weakening value of the U.S. dollar. Since May of 2007, the trade-weighted value of the dollar is down nearly 10 percent, according to the St. Louis Federal Reserve's latest data. Similar drops in value have occurred against the Taiwanese dollar, the Chinese Yuan, and the Singapore dollar. The fall in value has been even steeper in Latin America, where the dollar is down 16 percent against the Brazilian Real and 14 percent against the Peruvian Sol. Followers of currency markets will note that the U.S. dollar has been slowly weakening since early 2002, and if this trend should reverse itself, all international investments will begin to decline in value.

J. Gibson Watson III (watson@primacapital.com) is president and CEO of Prima Capital, a Denver-based firm that conducts objective, institutional-quality research and due diligence on SMA, mutual funds, ETFs and alternatives.

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