>MACRO DRIVERS AND EM EQUITIES (MERRILL LYNCH)

■ Macro framework for EM equities
We focus on oil, the EMBI spread and USD as our major barometers for growth, risk and flow in emerging markets. We test the sensitivity of EM equity markets to the three macro drivers (table 1). When combined into a simple regression equation, they together explain 86% of the movement in the MSCI EM index. A “fitted” macro framework for MXEF based on the three macro drivers closely tracks the actual index (see chart 1 in report).

■ Comfortable with 500-850 trading range for EM
Our macro framework can quantify the risk to the current level of MXEF. Plugging in the current values of oil, USD and EMBI, the macro framework says MXEF “should be” 8% lower than current actual level. So MXEF is hardly stretched. Using our strategists’ forecasts for oil, USD and EMBI for end-09, the framework says MXEF should end this year 13% down on the current level. We are comfortable with a 500-850 trading range for MXEF in 2009.

■ Stress-testing EM equities
Can MXEF break through the 1000 level? The framework says we would need oil up to $84 & DXY down to 65 & EMBI spread down to 300 - this bullish combo seems unlikely in our view. What needs to happen for MXEF to break below 550? Oil down to $55 & DXY up to 90 & EMBI spread up to 500 - this bearish combo seems unlikely in our view.

To see full report: MACRO DRIVERS