Chinese investors are hoping the Year of the Rabbit will bring better fortune than the volatile 2010 Year of the Tiger.

As mainland markets re-open following the Lunar New Year celebration, China’s Shanghai Composite Index has underperformed global stock markets in recent months ... despite posting one of the highest economic growth rates on the planet.

Just as in the US, massive government stimulus and easy monetary policies helped propel a broad rebound in Chinese shares early in 2009, but the Shanghai market peaked in August 2009 and has been mostly trending lower ever since. In 2010, the Shanghai Composite declined 12.8 percent while the US S&P 500 Index advanced 15 percent.¹ This is in spite of the fact that China’s economy expanded nearly 10 percent last year compared with US GDP growth of just 2.8 percent!²

China’s stocks aren’t an isolated example. The divergent paths between US stocks and other emerging markets is just as striking.

India, another emerging market favorite, has seen its main stock market index decline about 12 percent year-to-date, even after its economy expanded 10 percent. And Brazil’s GDP rose nearly 7 percent year-over-year, but that hasn’t kept share prices from sagging; as evidenced by the decline in the Bovespa, Brazilian stocks are down almost 6 percent this year.³

Threat of Emerging Inflation

What’s the culprit behind sagging emerging market stocks? Inflation.

Consumer price inflation in China is up 4.6 percent year-over-year. In Brazil, inflation is 6.2 percent ... and consumer prices soared 9.5 percent in India. Meanwhile, US consumer price inflation is running at just 1.4 percent over this same period.⁴

The threat of inflation can be much more socially destabilizing in the emerging market world because consumers there spend a much greater share of their income on the necessities of life ... especially food.

Global food prices soared over 27 percent higher in 2010 alone, putting a heavy burden on emerging market economies.⁵

Not surprising, central banks in a number of emerging markets are responding to the threat of inflation by raising interest rates. In fact, China’s central bank celebrated the Lunar New Year with another interest rate increase yesterday. It was the third time Chinese authorities hiked benchmark rates since mid-October. And the People’s Bank of China is not alone.⁶

Most emerging market central banks are now hiking interest rates, but investors fear they may already be falling behind the inflation curve — perhaps requiring more aggressive tightening this year.

The worry is that higher interest rates could choke off rapidly growing emerging market economies. And this appears to be the main reason why investors’ love affair with emerging stock markets has cooled recently.

Global investors are clearly concerned about the potential for a steeper correction in emerging stock markets should growth disappoint.

Going Global By Investing Local

In contrast, US GDP growth is finally picking up strength, as we pointed out last week (Banyan Letter Issue #2). Inflation doesn’t appear to be a problem (not yet anyway) with the consumer price index declining over the past 12 months.

Meanwhile, it appears that the Federal Reserve is in no hurry to raise interest rates ... in fact, they’re still busy pumping more liquidity into the economy with QE2.

With sovereign debt problems still lingering in Europe ... the threat of deflation hanging over Japan ... and inflation concerns in emerging markets ... US large cap stocks may just be the best game in town right now — and poised to outperform other markets.

First, big US multinational companies earn a growing share of sales and earnings from fast-growing overseas markets. About 54 percent of total profits for S&P 500 companies come from foreign operations, not domestic growth.⁷

Second, firms with a greater focus on overseas business are growing faster than the rest. S&P 500 companies with at least HALF of their total revenue from foreign markets are enjoying 10 percent top line sales growth — compared to just 6 percent growth for firms dependent on US operations for the bulk of sales.⁸

Third, there are many great American businesses that are reinventing themselves by tapping into new opportunities for growth internationally...

Take Yum Brands (NYSE: YUM), the owner of fast food restaurants like Pizza Hut and KFC. Chinese consumers must think the Colonel’s chicken is “finger-lickin’ good” ... because Yum posted sales of $1.2 billion in China last quarter, opening 245 new restaurants in the country during the first nine months of 2010.⁹

Within China and other emerging markets, a rising living standard is fueling growth as these economies attempt to transition from an export growth focus to more balanced internal consumption growth. China’s economy, for example, is expected to grow 9.5 percent in 2011 ... with domestic consumers accounting for 42 percent of total GDP growth this year.¹⁰

Another large-cap US blue chip with a growing global presence is drug maker Abbott Labs (NYSE: ABT). The company is expanding its business in Eastern Europe, India and Brazil because they see accelerating pharmaceutical growth potential in these markets.¹¹

Or consider Whirlpool (NYSE: WHR), the US-based maker of home appliances. Every home in America may already own a washer and dryer ... but emerging markets households are just getting used to enjoying such luxuries — and demand is booming. Latin America now accounts for 22 percent of Whirlpool’s total revenue and sales jumped 18 percent last quarter alone, compared with flat domestic sales.¹²

Bottom line: We’re convinced that select, high-quality US stocks with a strong global presence are among the most attractively priced assets in the world right now. And they may experience less price volatility than the emerging market stock indexes.

This can give you the right opportunity to tap into faster growing global markets by investing in more familiar, local blue-chip stocks.

Good investing,

Mike Burnick
Director of Client Communications
Banyan Partners, LLC

P.S. My colleagues and I will be at the World Money Show in Orlando on Friday, February 11 to present 7 Financial Flash Points for 2011 at the Gaylord Palms Resort. If you plan to attend this event, be sure to stop by for our briefing Friday afternoon at 2:35 p.m.!

The investment ideas discussed in this report may not be suitable for you. Please review your own specific financial objectives and circumstances prior to making any investment decisions. All investments carry risk and there are no guarantees that any of the ideas or recommendations made in this presentation will obtain their objectives.

As of the date of this newsletter, Banyan Partners had discretionary control over long positions of ABT, WHR, and YUM in certain of its client portfolios.

¹ Bloomberg market data, 2/8/11
² Decision Economics: Global Economic Developments, 2/4/11
³ Ibid.
⁴ Ibid.
⁵ Index Mundi.com; International Monetary Fund
⁶ Bloomberg News: China Raises Key Interest Rates to Counter Inflation, 2/8/11
⁷ Ned Davis Research: Global Digest, Jan. 2011
⁸ CNN Money.com, 2/1/11
⁹ Ibid.
¹⁰ US Global Investors: Weekly Investor Alert, 2/4/11
¹¹ CNN Money.com, 2/1/11
¹² Standard & Poor’s, 2/5/11; Dow Jones Newswire, 2/2/11