It's early. The results are open to revision and interpretation. And one month doesn't make an investable trend any more than a single swallow makes a spring.

But have you noticed? In the past month, emerging stock markets, such as China and Brazil, have outperformed the U.S. market.

And that's an absolute turnaround from results in 2010 and for most of 2011.

Does it mean that we're about to reverse the pattern that's held for more than a year and see emerging markets start to outperform developed markets? Well, sort of. The picture right now shows that the outperformance is limited to some emerging markets, and even in those markets, the outperformance is spotty.

But I think there's the beginning of a trend here that your portfolio needs to respect. And because it's so early, you need to pay attention to what kinds of stocks in these emerging markets investors are willing to buy right now.

Image: Jim Jubak

Jim Jubak

By the numbers

Here are the data.

U.S. markets: For 2010, the Standard & Poor's 500 Index ($INX) was up 15.02%. For 2011, as of Nov. 15, the S&P 500 was up 1.65%. In the past three months, it gained 5.05%. In the past month, 2.85%.

Brazil: For 2010, the iShares MSCI Brazil Small Cap Index (EWZS) was up 7.69%. For 2011, as of Nov. 15, it was down 19.54%. In the past three months, the loss was a more modest 2.80%. In the past month, the index climbed 4.35%.

Yep. In the past month, the Brazil index beat the U.S. market. After trailing for 2010. After getting killed in 2011 to date. After trailing badly over the past three months.

China shows the same pattern -- with some important wrinkles.

In 2010, the iShares MSCI Brazil Small Cap Index (EWZS) was up 7.58%. For 2011, as of Nov. 15, it was down 11.31%. For the past three months, the loss was 5.13%. And in the past month, the index climbed 4.77%.

In other words, exactly the same pattern as Brazil -- well behind the U.S. market until the past month, and then outperformance. Significant outperformance. We're talking a 2.85% gain for the U.S. index versus 4.35% for Brazil and 4.77% for China.

Bigger is better

One interesting wrinkle is that you could have done even better investing in China recently if you'd picked a different index. If instead of the SPDR S&P China, with its 4.77% gain in the past month, you had invested in the iShares FTSE China 25 Index (FXI), you would be looking at a 9% gain in the past month. (And a much lower 0.76% loss over the past three months, too.)

What's made the big difference in the gains from the two indexes? Size, in my opinion.

The average stock in the very concentrated FTSE China 25 Index has a market capitalization ---a total market price -- of $72.6 billion, according to Morningstar. These are huge companies -- and indeed, Morningstar categorized 92.4% of the index holdings as "giant." (This isn't exactly a surprise; the mandate of the index is to invest in the 25 largest Chinese companies listed in Hong Kong.)

The average stock in the SPDR S&P China Index isn't a small cap by any means (although the index does include a 0.43% weighting of small-cap stocks and even a 0.19% weighting of microcaps). But the average holding is a smaller (if still very large) $27.7 billion. Only 61.2% of holdings qualify as giant, according to Morningstar. The index even includes an 8.2% weighting to stocks that qualify as midcap. (The index is a market-cap-weighted index of 130 stocks that trade in Hong Kong, or as U.S. listed ADRs, or are listed on the New York Stock Exchange.)

There's isn't a similar big and bigger index pair for Brazil. But comparing the gains of the iShares MSCI Brazil Index with those of the iShares MSCI Brazil Index (EWZ) makes a similar point: Size matters very much right now.

In the month ended Nov. 15, the small-cap Brazilian index (the average market cap of its holdings is $776 million) showed a 2.28% gain, compared with the 4.35% gain for the iShares MSCI Brazil index (average market cap: $21 billion). Only 22.2% of the latter index is made up of midcap companies, and a tiny 2.2% consists of small-cap stocks.

Why size matters

Why the discrepancy between big- and small-cap performance in Brazil and China as these markets show signs of moving out of the downturn that has ruled them since they peaked back in November 2010?

A couple of factors explain it, I think.

First, the early cash flow moving into Brazil and China is dominated by institutional investors who:

  • Favor big stocks when they put money to work, because they want to be able to deploy substantial cash without raising the price of the stock they're buying (until they're done buying).
  • Want to make sure they can get out as easily as they got in.

Think it might be easier to move in and out of Petrobras (PBR, news), with its $173 billion market cap and U.S. ADR, than Kroton Educacional (KROT11, in Brazil) with its $968 million market cap and no U.S. listing? All else being equal -- though of course, it's not when you compare an oil company with an education company -- size explains why Petrobras is up 8.9% in the past month, while Kroton Educacional is down 0.06%.