Should you bet on equities or commodities in medium term?

The outperformance of the Nasdaq over the Reuters commodity index in the past year is a sign of market trends going forward.

Nasdaq, which is a technology weighted index, has given a return of 11 per cent since April 2011. In contrast, the Reuters CRB Commodities index, which tracks a basket of 19 commodities, has fallen 13 percent since April 2011.

The trend of outperformance of equities led by knowledge stocks will continue going forward given the positive outlook for the US economy, as well as given the weak growth outlook for growth economies such as China and India.

[caption id=“attachment_264658” align=“alignleft” width=“380” caption=“The US is looking more dominant now than it was in the 2000s after the technology bubble crash, which took the Nasdaq down by 60 percent from highs. Reuters”]  [/caption]

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The US is looking more dominant now than it was in the 2000s after the technology bubble crash, which took the Nasdaq down by 60 percent from highs. The Nasdaq has stayed well below 5,000 levels since the crash, and is currently trading at levels of 3,000.

However over the past ten years there has been a significant rise in technology companies led by stocks such as Apple, Google, Amazon and Facebook. These companies are now dominant across the globe.

Apple has attained the status of the most valuable company in the world in terms of market capitalisation, while Google and Amazon have changed the face of the Internet and Internet retailing. Facebook has attained a valuation of $100 billion in just over a span of eight years and is slated for listing on the bourses. The fact that the fastest growing business in the world, the Internet, is dominated by US companies has increased the presence of the US across the world.

The smart gains of the Nasdaq over the past year against commodity sensitive indices, such as Brazil’s equity index the Bovespa, which is down over 5 percent over the past year, reflects the emergence of technology as the new driver of markets.

The underperformance of China’s Shanghai Composite, which is down 23 percent over the past year, highlights the issues facing economies with relatively lower intellectual capital.

India too has had its share of problems due to poor governance that has lifted inflation and worsened government finances; its indices are down close to 10 percent over the past year.

However, India is on a much better footing than Brazil and China given that the country has a strong information technology base that derives over 60 percent of revenues from the US.

India is in a position to participate in the technology dominance of the US going forward, unlike China and Brazil.

The fact that the Internet economy is growing from strength to strength at an expected growth rate of 8 percent per annum until 2016 for G20 nations (BCG research) will help propel higher equity markets that have a higher weight of technology.

On the other hand, markets weighted by commodities will underperform as a strong US dollar and below trend growth in countries such as China and India will limit the rise of commodity prices.

The US Dollar index, which tracks the dollar against six major world currencies, has gained by 3 percent over the past one year, while the euro has dropped by 5 percent against the dollar in the same period. The Indian rupee shed 14 percent against the dollar in the past one year.

Global markets prefer the US to other nations’ equities and currencies primarily because of the improving health of the US economy. The economy is adding jobs every month: over the past six months, it has added 1.2 million jobs.

The US unemployment rate is down to 8.3 percent from levels of 9.5 percent, while its fourth-quarter GDP for 2011 rose by 3 percent (annualised) against 1.8 percent growth in the third quarter.

GDP forecasts for the first quarter of 2012 are being revised upwards given strong retail sales in February 2012. A strong dollar will keep commodity prices in check.

Meanwhile, the economic outlook for the eurozone, China and India do not look very rosy. The eurozone economy is likely to go into a mild recession in the beginning of 2012 before recovering, while China and India forecast growth of around 7.5 percent for this year - much below the trend growth levels seen since the mid-2000s.

Each of these economies have issues in the form of huge sovereign debt (Eurozone), property bubbles and non performing loans (China) and inflation and weak government finances (India).

Below-par performance of these large economies will lower demand for commodities and cause prices to stagnate.

Arjun Parthasarathy is the editor of www.investorsareidiots.com, a web site for investors.