It has been a dreadful start to the year for global equity markets -- but one trend is clear. Emerging markets have outperformed their developed world peers.

While the S&P 500 index was plumbing 12-year lows at the start of this week, the MSCI emerging markets index is up 10.6 per cent from its October 27 low. Since January 1, emerging markets have fallen 11.4 per cent compared with a 21.2 per cent drop in developed world stocks.

The 12.5 per cent EM outperformance this year is surprising. As any market strategist will tell you -- in times of stress when safe haven trades are in fashion, emerging markets typically fall faster than developed ones as investors switch out of what they deem to be riskier assets.

Michael Hartnett, global emerging market equity strategist at Bank of America Merrill Lynch, says: "It is certainly curious that the emerging markets have outperformed, when you look at the turmoil in eastern Europe, the collapse in exports that is hitting Asia and the continuing weakness in commodities that are so important for Latin America. You would not, at first glance, expect it. But there are reasons why they are outperforming."

Reason number one, according to Mr Hartnett, is China. The Shanghai Composite index has risen 17.5 per cent this year, whereas the S&P 500 index has fallen 20.6 per cent and the FTSE Eurofirst 300 is down 16.7 per cent.

China is still growing strongly and a massive fiscal stimulus package has led to hopes that it will be able to lead the global economy out of the downturn. Growth is slower than two years ago, but the country is still forecasting a growth rate of about 8 per cent for 2009.

This, in turn, will benefit the open economies in Asia, which rely on exports to China, says Mr Hartnett.

Another big factor is the positioning of investors. Many have already pulled out of the emerging market space. This was seen following the collapse of Lehman Brothers in September, when developing markets nose-dived.

The MSCI EM index fell 45 per cent in dollar terms from September 15, when Lehman Brothers crashed, to its October 27 low. Over the same period, the MSCI developed world index fell 33 per cent.

A third reason for EM outperformance is that concerns about the global financial system have been concentrated on western banks. Western banks are more highly leveraged and more exposed to toxic assets.

However, analysts are unsure whether EM outperformance can continue, particularly in Asia. For a start, Chinese growth may not be as fast as its leaders expect. On Wedneday, figures showed Chinese exports fell 25.7 per cent in February on the year, while imports dropped 24 per cent.

The stronger Latin American economies, such as Mexico, Brazil and Chile, which have navigated the world downturn fairly impressively, may also be heading for choppier waters.

In dollar terms, Chile's stock market has been the best performer of the year, according to MSCI, up about 8 per cent since January 1, while Brazil's equity market has been the third best performer, up 4.5 per cent.

By contrast, the four worst performing equity markets this year are Romania, down 60 per cent, Serbia, down 49 per cent, Hungary, down 39 per cent and Poland, down 33 per cent.

Central and eastern Europe have been at the centre of the economic turbulence this year because some countries have large current account deficits and big external financing requirements. Countries such as Poland, Czech Republic, Hungary and Turkey have also been battered by currency volatility.

The difficulties still faced by these economies is making international investors wary, says Karine Hirn, chief executive of East Capital, the Swedish fund management group specialising in east European markets. "We have started to see some interest in these markets, but it's very little. Investors are taking a wait and see approach. But the ones that wanted to sell have sold -- they have already left the market," she says.

Stuart Culverhouse, chief economist at Exotix, says individual emerging markets have different strengths and problems. In the case of Latin America, most problems centre round slumping consumer demand because of sharply higher interest rates, rather than weakening exports, which is starting to afflict the Asian economies.

Latin American markets are also being hurt by weak commodities prices. This is the same for Russia and a number of Middle Eastern economies, which have seen their markets fall in line with lower oil prices.

Shahin Vallee, emerging markets strategist at BNP Paribas, believes the actions of central bankers in the developed world may prove critical. "We have seen how helpful the US Federal Reserve has been for some of the emerging economies when it offered dollar swap lines to Korea, Mexico, Singapore and Brazil. It would help eastern Europe if the European Central Bank was prepared to do the same thing," he says.

Mr Culverhouse agrees: "If the big central banks in the western world can stimulate demand with quantitative easing or other policies, that will be a major boost for the emerging world."

But Mr Hartnett warns: "Emerging market equities may be well above their autumn lows. But there is no doubt the death spiral in US financials threatens to take emerging markets back to old lows. And lower they may go until we see investors in the US Treasury market dramatically sell off in anticipation of the final inflationary solution for the US housing and banking sectors. This has not happened yet."

Copyright: The Financial Times Limited 2009