by Russ Koes­terich, iShares

Call #1: Neu­tral on Indonesia

I first advo­cated an over­weight view of Indone­sia back in early Feb­ru­ary. Since then, the mar­ket has bucked the neg­a­tive global trend. Since Feb­ru­ary, the iShares MSCI Indone­sia Investable Mar­ket Index Fund (EIDO) has gained roughly 9% and has out­per­formed the MSCI Emerg­ing Mar­kets Index by 25%. Indone­sian equi­ties cur­rently trade at 3.6x book value, more than twice the emerg­ing mar­ket aver­age. Past per­for­mance does not guar­an­tee future results.  For stan­dard­ized per­for­mance for EIDO, please click here.

Given the mag­ni­tude of this out­per­for­mance, Indone­sia no longer looks that cheap rel­a­tive to other emerg­ing mar­kets. As such, I’m clos­ing out my over­weight view on the coun­try, and I am mov­ing to a neu­tral stance.

Call #2: Over­weight on Taiwan

I’m see­ing bet­ter oppor­tu­ni­ties in other parts of South­east Asia, par­tic­u­larly in Taiwan.

Equi­ties in Tai­wan are also trad­ing at a pre­mium to other emerg­ing mar­kets, but the pre­mium is mod­est and is jus­ti­fied given Taiwan’s above aver­age growth prospects. Taiwan’s gross domes­tic prod­uct is expected to grow by 5% in both 2011 and 2012. Among other rea­sons to like Tai­wan, the country’s cor­po­rate sec­tor is prof­itable with a return on assets of 11.2%, well above the global aver­age. Taiwan’s div­i­dend yield of roughly 4.5% is also well above the global average.

But the Tai­wanese mar­ket is not with­out risks. Its biggest risk: Tai­wan is an export dri­ven econ­omy.  If the global econ­omy expe­ri­ences a dou­ble dip, Tai­wan will suf­fer. Still, I believe investors are being com­pen­sated for the risk (pos­si­ble iShares solu­tion: EWT).

Call #3: Mar­ket Volatil­ity Level is Closer to Fair Value

Finally, I want to pro­vide an update on my view of mar­ket volatil­ity. In mid-August, I sug­gested that mar­ket volatil­ity lev­els appeared extreme. At the time, the VIX — or volatil­ity index — was trad­ing in the mid 40s, more than dou­ble its long-term average.

While I expected a dif­fi­cult and volatile mar­ket envi­ron­ment, my analy­sis sug­gested that investors were over­re­act­ing. Volatil­ity was higher than it should be and was likely to fall. Since then, the aver­age level of the VIX Index has been in the mid 30s. It closed Thurs­day at around 30. This level is still ele­vated rel­a­tive to the index’s long-term aver­age, but it’s closer to fair value. As such, I’m no longer a seller of mar­ket volatil­ity. Going for­ward, assum­ing that Europe can address its imme­di­ate prob­lem and that there is no dis­or­derly default by Greece, I expect equity mar­ket volatil­ity to remain in the mid 20s to low 30s for the fore­see­able future.

Source: Bloomberg

The per­for­mance quoted rep­re­sents past per­for­mance and does not guar­an­tee future results. Invest­ment return and prin­ci­pal value of an invest­ment will fluc­tu­ate so that an investor’s shares, when sold or redeemed, may be worth more or less than the orig­i­nal cost. Cur­rent per­for­mance may be lower or higher than the per­for­mance quoted. Per­for­mance data cur­rent to the most recent month end may be obtained by call­ing toll-free 1–800-iShares (1–800-474‑2737) or by vis­it­ing www.iShares.com.

In addi­tion to the nor­mal risks asso­ci­ated with invest­ing, inter­na­tional invest­ments may involve risk of cap­i­tal loss from unfa­vor­able fluc­tu­a­tion in cur­rency val­ues, from dif­fer­ences in gen­er­ally accepted account­ing prin­ci­ples or from eco­nomic or polit­i­cal insta­bil­ity in other nations. Emerg­ing mar­kets involve height­ened risks related to the same fac­tors as well as increased volatil­ity and lower trad­ing vol­ume. Secu­ri­ties focus­ing on a sin­gle coun­try may be sub­ject to higher volatility.

Copy­right © Russ Koes­terich, iShares

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