Emerging Markets - Are you sufficiently exposed?

Pounding the point home, once again.

I have written a great many times (e.g. 1, 2, 3, 4 or all, 5) since this blog started over four years ago, about the need for any forward-looking, growth-oriented investor to have a very serious weighting in emerging markets. A recent article in the Financial Post, highlighting information from Goldman Sachs Global Economics Paper No. 204, makes the point worth repeating, once again.

They point out that the emerging markets now total some 31% of the global stock market capitalization, and suggest that this will expand to 55% by 2030. Is that shocking? Hardly. According to the OECD, a global club of rich countries, emerging markets already have 49% of the global GDP, on a purchasing power parity basis; and they appear slated to continue growing rapidly. Is it a surprise to think that their stock market valuations are slated to follow their growth?

What is shocking, is that against that, Goldman Sachs estimates that developed market investment funds hold just 6% in emerging market equities, out of their total equity allocation. They believe this will rise to 18%, by 2030. In other words, if you are a typical rich country investor, a peek behind the curtain of investments that YOUR investment advisor has gotten you into, would reveal that you are sitting at just 20% the emerging market exposure you should be at, assuming you simply want to mirror the world economic powers (e.g. 6% divided by 31% = 20% exposure). By 2030, the situation gets somewhat better, but your exposure would still be wildly low, compared either to world GDP then, or emerging market stock market capitalizations.

If you wanted to simply mirror global market returns going forward, then seriously underweighting one of the two most easily visible growth investment themes going forward sure isn't the way to do it. If you wanted outsized returns, then you'd likely seek even more participation in rapidly growing economies, assuming you have decent entry points, e.g. valuations not stretched. (Are they currently too high? Not in my book. They are trading at an average PE ratio of just 12, according to the Financial Times, which compares to a PE on the S&P 500 of 14.7).

The other thing to know here, is that the emerging markets are no longer the wild west. They have solid economic principles they are managing their economies on, and populations of great savers (oh, if only the western world were so lucky now!). This makes it pretty easy to suggest that their stock market volatility is going to continue to move down, especially compared to the overleveraged and overspent rich countries.

If you are a growth investor, go wake up your investment advisor, and demand he or she explain exactly why your emerging market exposure is so darn limited.

Disclosure: Participant in the emerging markets theme via DEM, DGS.

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Investing Requires Flexibility to Take Advantage of Conditions

I wasn't sure whether to title this as "Investing requires flexibility", "Rush to liquidity won't necessarily improve investing results", or "US dollar strength won't last".

And that's because, currently, all three are tied together. Nearly every currency in the world has been pounded against the US dollar recently, as there's been a rush towards that currency. Now I can't say that I fully understand all of the reasons for that, but even currencies that should theoretically be strong have been caught in the backwash over the past few months. If you take a look at this currency chart, you can see that virtually every currency therein is down - and in many cases down very significantly - against the USD over the past three months.

So as bad as your short term investments might have done during this turmoil, if they were effectively denominated in other than USD, those ones probably did worse.

Furthermore, during this rush to liquidity (i.e. large cap US stocks, cash and equivalents) has left a lot of other quality investments (but which are less liquid) looking as roadside kill. However, for longer term investors who have too much of their portfolio dominated by USD products, this now presents some wonderful opportunities - perhaps opportunities you missed a couple of years ago.

For some, this might mean moving away from quality US stocks, to other developed country quality stocks. For others, this might mean finally buying the appropriate level of emerging economy stocks (or ETFs). Still others might use this opportunity to position themselves in quality small company stocks.

Whatever or however you decide to approach this opportunity, be aware of two factors: the pounded down overseas relative stock values won`t last - and neither will the current USD strength. Take this bear market opportunity to position your portfolio to look great five to ten years out. Be flexible.




JW

The Confused Capitalist

Three Excellent Emerging Market ETF's

The other day, I posted about two popular emerging market ETF (EEM, VWO) choices. While you aren't likely to go too wrong adding one of these two major ETFs to your portfolio, I believe you can do better.

The three choices I examine here are all fundamental analysis ETFs, rather than based on old-fashioned market weighted capitalization like the prior two choices. What this means is the underlying stock choices are chosen on a rules-based entry system rather than how fat (or skinny) the valuations have gotten. I have written about fundamental analysis systems before, including here and here.

Wisdom Tree has used a dividend-rating system to select stocks most likely to outperform. This is based on back-testing that has shown that, firstly, dividend-paying stocks outperform their non-paying brethren, and secondly, that higher yields more often than not indicate relative undervaluation. Finally, Wisdom Tree's research shows that a basket of these stocks also have lower volatility than a comparable market-cap index.

The FTSE RAFI indexes, used in many Claymore and PowerShares products, uses four factors to weight stocks. These factors aren't related to the markets enthusiasm (or lack thereof) for the company itself, and extensive back-testing has shown these type of indexes outperform old-fashioned market cap indexes, such as the S&P 500, MSCI EAFE, and Dow Jones Industrial Averages. The factors are dividends, cash-flow, book value and sales.

The three choices we are looking at are Wisdom Tree and PowerShares products. They are the PowerShares FTSE RAFI Emerging Markets ETF (PXH), the WisdomTree Emerging Markets High-Yielding Equity ETF (DEM), and the WisdomTree Emerging Markets Small Cap Dividend ETF (DGS).

Let's take a look under the hood of these choices. Firstly, cost and turnover. On cost, none of them has a significant cost advantage, with DEM and DGS are 0.63%, and PXH at 0.85%. Turnover in PXH is 8% annually, with DEM at a remarkable 3% annual turnover. DGS does not have a reported turnover, but given that this is a small cap ETF, you can expect it to be relatively high, certainly higher than any of the choices I've discussed to date.

Let's look at the average company size and some of the top sectors in each product. In terms of average company size, these are all distinctly different products. DGS defines 92% of their portfolio as small cap, with the remainder as mid-cap. DEM is relatively agnostic for cap size, with 39% defined as large cap, 41% as mid-cap and 20% small cap. PXH, on the other hand, is primarily a large cap ETF, with 88% so defined, plus another 8% as mid-cap and a smattering of small cap.

In terms of the top four sectors, finance holds first or second place in all of them, and ranges from 26% in DEM to 19% in both DGS and PXH. Energy achieves one of the top four spots only in PXH, and there it holds first place with 26%. Information Technology holds down fourth spot in all the portfolios and range from 10-16%. Materials, at 14% is unique to DEM, while telecomm at 15% is unique to PXH. DGS has consumer discretionary in top spot at 19% (a unique top four holding) and industrials in third spot at 17% - again a unique top four holding.

Stock concentration is quite different among the three choices, with DGS holding around 400 stocks, and with the top four stocks holding 4.3% of the total portfolio value, and the top 20 companies accounting for 16% of the portfolio.

DEM holds around 300 stocks, with the top four stocks comprising 11% of the portfolio value, and the top 20, some 38%.

PXH is heavily concentrated by comparison to all of the choices reviewed so far: it holds around 160 stocks, the top four stocks account for a heavy 26% of the portfolio value while the top 20 stocks hold 60% of portfolio value. Essentially, this portfolio lives and dies with the top 20-30 stock choices.

Let's turn to country selection. In the Wisdom Tree ETFs, the top two countries represented in these ETF's are the same, with Taiwan holding top spot in both between 26-29%, and South Africa coming second at 11-15%. Brazil, Turkey, Malaysia, and Thailand fill out third and fourth spots at between 8-9% with the Asian choices in the DGS ETF.

The PXH ETF has China in top spot with 19%, South Korea with 18%, Brazil with 15% and Taiwan with 14%.

Finally, we turn to relative value measures of the portfolio. Dividends, as can be expected, rate high in the Wisdom Tree products, with recently reported yields of 7.92% (DEM) and 6.17% (DGS). The yield is not reported for PXH, but I'd say a reasonable guess, given portfolio size, and that consideration is given to firm size including dividends, would be in the 3-4% range.

PE ratios are attractive across the board, with DGS unexpectedly at the low of 9.3, DEM at 9.8 and PXH at 10.2. The price-to-book ratio varies from DGS, again at the low of 1.1, to 1.9 for DEM, and PXH at 2.7. Finally, the price-to-sales ratio is given only for DGS and DEM, at 0.71 and 1.21 respectively, which are both attractive, particularly the DGS.

Finally, let's look at the performance of these products year-to-date (note: DGS and PXH are less than one year old, hence the YTD comparison), compared to the iShares MSCI product EEM.

(Click to expand in size)



While PXH looks alot like EEM on the above chart, I believe that this is coincidental to some extent and the differences in the products will reveal themselves over time.

Looking at the products, DEM certainly appears to have low volatility, making it an easy choice for investors who prefer low volatility. Furthermore, the process for inclusion into the ETF also makes significant outperformance a reasonable possibility going forward.

DGS has relatively low volatility given its small cap orientation. I think of it as having just large cap volatility, but with the promise of small cap returns and a better selection process.

PXH is the large-cap ETF of the three. Offsetting to this usually comforting factor are the rather large bets on a relatively few number of firms, something you have to be comfortable with in order to be comfortable holding this ETF. On the other hand, the selection process is likely the most robust over the long haul for outperformance.

I lean slightly more toward the dividend approach in this instance, rather than other relative valuation measures, since other measures are more likely to be manipulated by accounting shenanigans, or simply poor disclosure practices. As the saying goes, "Dividends don't lie" ... and "Dividend investors sleep better". So for my money, I prefer the two Wisdom Tree products in this instance, although I have enormous belief that the PowerShares product will also prove itself over time.

In conclusion, I don't think the relatively low expense ratio of VWO is superior to the relatively low portfolio valuations offered by these three products and the superior selection process they employ, compared to both EEM and VWO. I believe the returns on all three of these products will outpace EEM and VWO over time.

Disclosure: Long positions in DEM, DGS.



JW

The Confused Capitalist

Emerging Markets Choices

Recently, some members of the investment business have suggested that emerging markets offer unusually good value.

This, of course, offers me the opportunity to once again explore one of my favorite topics.

According to one recent article, despite the growth of emerging markets to currently represent 13% of the world stock market capitalization, British investors have only 1.6% of assets in those markets. Presumably, American and Canadian investors are in the same boat.

This is all the more alarming given that these markets are widely forecast to achieve 50% of the world economy in 20-30 years time. That means that most investors aren't playing the largest visible theme of our times.

Given the growth in ETF's and mutual funds catering to this segment, there's no excuse for most stock investors with a 10-15 time horizon not to be in this market. This is a growth component that simply must not be ignored.

Having said that, I'd like to take a look at two of the most popular emerging market ETF market-capitalization choices, plus three ETF choices from purveyors who use a rules-based fundamental analysis to choose an emerging market basket.

The first two are choices from Barclay's iShares (EEM) and Vanguard (VWO). They are based on selecting on tracking broad-based market-capitalization based indexes. Market capitalization indexes (such as the S&P 500, MSCI EAFE, etc.) select the largest companies by market capitalization for inclusion into the index.

Critics argue that these type of indexes over represent over-valued companies, and under represent undervalued companies, and investors therefore leave some potential alpha on the table, while attracting unwanted volatility. On the other hand, supporters of these indexes argue that, despite these flaws, owning such an index proxy is still a reasonable way to participate in most of the stock markets gains, in a tax and cost efficient manner.

Let's take a look under the hood of both of these choices.

Firstly, cost and turnover. On cost, Vanguard (VWO) has it's legendary cost structure sliced to the bone, with just a 0.25% cost, while the Barclay's product (EEM) has a 0.74% cost. A 0.49% point advantage isn't to be sniffed at, but it't not the only item of consideration. Turnover for VWO is 9% annually, the second highest rate amongst the five products we'll look at. The iShares EEM has a turnover of just 5% annually. In a non tax-deferred account, these two cost and turnover factors are offsetting, with no clear winner. In a tax deferred account, the VWO is the better choice, if these were the only two factors under consideration.

Let's look at the average company size and some of the top sectors in each product. and company size. country choices. In terms of average company size, both are similar with Morningstar defining between 77-80% of the companies held therein as large or giant, and between 18-22% as mid-size. That means either fund has virtually no exposure to small cap stocks, and both can be thought of as large cap ETF's.

In terms of the top four sector allocations, both have financial firms (banks etc.) at between 18-22% of the fund, energy at between 16-20%, and materials between 18-21%. The only difference is for the fourth choice, which for iShares EEM is information technology at 14%, while for Vanguard VWO it is telecommunications at 12%.

In terms of individual stock concentration, the top four choices of EEM comprise some 16.2% of the portfolio value, while for VWO it is 12.2%. The top 20 choices comprise some 40% of the value of EEM, while for VWO it is 27%. EEM holds about 350 securities in total, while it's nearly 900 for VWO.

On these three later factors of market size, sector choice and stock concentration, there isn't that much to choose between these. So let's turn to country selection.

In both ETFs, the top four countries represented in these ETF's are pretty similar, with Brazil in first place representing 16-18%, and either China or South Korea in second or third place between 11-13%. The difference is in fourth place, where Russia represent 11% of EEM, while fourth is held by Taiwan in VWO, again with 11%. Overall, once again, very little to choose from between the two.

Finally, we turn to relative value measures of the portfolio. However, I have to complain about "the people's choice", Vanguard, long a champion of the individual investor. Their disclosure of valuation of the portfolio, in a word, sucks! The only valuation measure they offer is price-to-book (PB) ratio, wherein all of the other choices we'll look at provide at least the price-earnings (PE) ratio and the dividend yield of the portfolio, with some others also providing the price-to-sales (PS) ratio.

Having said that, the PB ratio of VWO is 2.8, compared to 3.7 for EEM. Morningstar calculates the dividend yield at 2.22% for VWO and 2.70% for EEM. Combining these two measures of relative valuation, suggest these portfolios offer relatively similar attractiveness from a valuation standpoint.

Yahoo calculates the PE of EEM at 11.9 (versus iShares own calculation at 18.0), and VWO at 13.0. Given the differences in PE calculations I've seen between Yahoo and ETF providers themselves, I don't think the Yahoo calculations are particularly reliable. On the other hand, Morningstar calculates the cash-flow ratio of both portfolios to be between 8.5 (EEM) to 8.9 (VWO). Therefore, there's little to choose from here, except to say that both portfolios appear relatively expensive, given the valuation characteristics of the three other product choices that I'll cover in a future posting later this week.

And, although no one looks at historical charts - given that we're all aware that past performance is no guarantee of future performance, let's see how the two products have performed against each other and the S&P 500 ETF (SPY) over the past year.



Given the similarity between the products, I'd say it's hard to pick a clear winner. Perhaps if Vanguard would get into the modern era, and provide its investors better information, as well as it's outstanding cost structure, it would be easier to make a choice between these two.

Later this week, I'll look at three fundamental analysis ETF choices.

Disclosure: No positions held.


JW

The Confused Capitalist

Sectors Still Look Poised for Outperformance

Back in August, right near the bottom of the mini-plunge, I suggested several sectors whose stocks looked poised for outperformance over the longer term, as well as a couple of groups to avoid.

The groups I liked included some of the bigger banks (although I warned that further declines of 10-20% also looked possible), whose yields were then in the 3.4% to 5.0% range or so.

They also included some of the large engineering firms, who I see as prime beneficiaries of the design and oversight work needed to build out the emerging markets infrastructure, and the work needed to replace the aging infrastructure of the western world.

It also included several emerging markets suggestions, and a later posting suggested that distressed credit buyers would have the opportunity to load up their balance sheets with cheap debt, which could fuel earnings for years to come.

Since those predictions, the S&P 500 has bounced up and then down, and is essentially flat over that period.

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The banks mentioned have generally declined, most by about 10-20%, but with Citigroup getting trashed. On the other hand, some have held up pretty well, considering the magnitude of write-offs announced since then. I still like them, and now most of the yields are now in the 5-7% range, making them even more attractive in the face of what I see as a weak market. Maybe it's just me and Warren Buffett who like the bank stocks at these prices.

Engineering firms still look good as a look term-prospect, but this may be somewhat tempered by the fact that most of those discussed have moved sharply upwards, by 10-50% since then.

The emerging markets suggestions have also moved up, by about 15-20% on average of the group discussed.

Finally, a later August 2007 suggestion of looking at some distressed credit buyers is essentially flat as a group.

I still like all of these groups, and think that current prices are likely to look good several years from now.




JW

The Confused Capitalist

Emerging Markets hold the line in equity decline

Has the egg finally cracked?

I postulated, last year, that emerging markets were a better value proposition that widely acknowledged, with their strong economic fundamentals, and solid government financing, in sharp contrast to most western nations, and particularly the US.

The WS Journal chart below (via Barry Ritholtz's Big Picture), shows that, globally, the emerging markets were the only major stock group to end the week in an up position.

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Perhaps this is the start of the trend I've envisioned, wherein emerging markets, and the developed nations, re-balance to more appropriate valuation ratios, based on the conditions actually in existence today.

Or perhaps this is just a short term blip ...

JW

The Confused Capitalist

WallSt.Net Podcast

Welcome to everybody from WallSt.net who came over here because of the podcast interview with Dennis Olson (Haven't heard it? Go here; it'll be on their site on Wed. Aug. 15th). Thanks to Dennis and WallSt.net.

This posting is essentially related to some stuff I talked about on the podcast.

Firstly, anyone interested in buying my book can go here.

Secondly, in terms of some of the stuff I talked about in the podcast about why this blog is a bit different than many out there, I mentioned specifically, dividend investing, and long-tail investing. Here's a couple of articles I've posted that kind of give you a bit of the flavor of these topics, here, here and here. And for those who know me and my bent towards value investing, I re-submit this evidence ...

Now, in terms of stuff I specifically recommended (either avoiding, or moving towards) ...

AVOID

Real estate stocks, especially home-builders (see the reasons why, in an article I wrote in my other life) and avoid sub-prime lenders; the first for three to five years; the second for two plus years. Pessimism after that will be prevalent and then would be the time to buy. There's still too much optimism in the market.

BIG BANKS

Conversely, the really big banks are getting tarred with the "sub-prime" brush, which isn't warranted, in my view. Many of these institutions are tremendously strong, with great balance sheets and will easily weather this storm, and perhaps come out of it with better than ever opportunities. They're also paying great dividends right now, and most have raised their dividend recently. This is another sign that they are probably being mis-priced in the market. Some to look at would include:

• CITIGROUP - yielding about 4.6%



• Wells Fargo - yielding about 3.4%



• Bank of America - yielding about 4.6%



• Wachovia - yielding about 4.6%



• US Bancorp - yielding about 5.0%

Of course, those risk-takers might wait for the next mini-plunge which, if it occurs, might raise these yields by another 50 to 100 basis points (i.e. prices might fall by another 10-20%). However, I think they're good enough deals as they sit. Don't delay too long on these folks - "on sale" today!

EMERGING MARKETS
Emerging markets remain a very-long-term theme that investors will be able to successfully play for a decade at least (provided the stocks don't get overpriced). On a purchasing power parity (PPP) basis, these economies currently account for about 20-25% of world trade, yet most conventional financial advisers suggest a 5% weighting or so. This is a serious backward-looking mistake. No investor with a 20 year horizon can afford to take such a light weighting in these strong growth markets.

While the conventional BRIC countries have been bandied about as "the" emerging country investment destinations, other countries also have strong profiles too. A personal favourite of mine remains South Korea, with nearly an "emerged" economy, yet very cheaply priced.

Here's some ways to play the emerging markets theme, via ETFs, in my personal order of preference:

• Wisdom Tree's ETF - "DEM" - a dividend-weighted emerging market ETF. This ETF should prove more resilient than many emerging market investments during market corrections, while retaining most of the upside during exuberant bull markets.


• The Claymore Investments ETF - "EEB", which is designed to provide exposure to the BRIC countries, through ADRs. Because ADR issuers tend to be large, liquid companies, this also reduces some risk.


• The iShares S.Korea ETF, "EWY" - a narrow singly country focussed ETF.


• The iShares Emerging Market ETF, "EEM" - a very broadly-based emerging market ETF.

AGRICULTURAL COMMODITIES

I think this sector is going to have a huge tailwind going forward, something I've written about here. In later postings, I'll elaborate on how to play this trend.

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INFRASTRUCTURE BUILD OUT

This is tied in with several other trends, including the re-building of the industrialized world's infrastructure to make it greener (using mass transit for instance, to replace the crappy aging stock of roads and bridges).

Also, the infrastructure build out in the emerging markets is something that's going to continue to occur during the next several decades. For instance, the Chinese GDP per head is about 1/4 of what it is in the US (on a PPP basis), while in India it's about 1/10 (PPP basis). These economies will also obviously be building out their infrastructure. Accordingly, I like some of the very large manufacturers, like General Electric ("GE") & Siemens AG ("SI"), but I especially like the engineering firms that'll obviously be beneficiaries of the design and over-sight work needed here. Some names in this sector include:

• Fluor Corp. - FLR


• Foster-Wheeler - FLWT


• Jacobs Engineering - JEC


• Stantec Inc. - SXC


• SNC Lavalin - SNC (on Canada's Toronto Stock Exchange)
  

Well, that's about all for right now - if you're new to the site, feel free to poke around. If you're a regular, thanks for coming by.

JW

The Confused Capitalist

Emerging Markets

I was recently forwarded a paper written by Goldman Sachs reseachers in October 2003 relating to the potential of the BRIC emerging economies. I have written on emerging market potential outperformance many times (and here, and here too) before.

The paper projects that, given favorable growth regimes in those countries, that these economies will be one-half the size of the G6 by 2025, and larger than them, as measured in USD, by 2040. In fact, the world's largest economy in 2041 is predicted to be China.

The paper has obvious implications for any forward-looking investor. They also suggest that one expectation is that average currency appreciation for BRIC nations will be by about 2.5% annually for these currencies over the next 45 years. That's a pretty good tailwind alone, for investment results.

As the paper points out, things could obviously go wrong over that time period, but these results have reasonable potential to occur. Under the assumptions laid out in the paper (and with their model checked against history in other nations), it suggest that the largest economies in 2050 will be as follows:

1. China
2. US
3. India
4. Japan
5. Brazil
6. Russia

In other words, BRICs will have four of the top six spots. I think long-term investors should pay attention here, and try to understand why your particular investment advisor might be suggesting emerging market investment ratios of below 15% or 20% of your portfolio (which is actually below their current world GDP share in US$, at roughly 25%).

What also brought this issue into sharp relief for me, again, was a recent Economist magazine special on the world economy, that focussed on the emerging economies of the world. To an investor that wants growth at a reasonable price, these economies are growing their GDPs over the past five years at 5.6% annually, versus 1.9% for the developed world.

A forward-looking investor can't afford to ignore these reasonably-priced markets, and excellent growth prospects going forward. Are you such an investor?


JW

The Confused Capitalist

The China file

A couple of items in the news medium recently caught my attention, both relating to a favorite topic of mine: emerging markets. I have long argued (1,2)that most long-term investors are poorly served by the traditionalist advisors on the emerging market side, suggesting that portfolio weightings of 5%, or perhaps 10% are appropriate.

China recently announced blow-out numbers, with second quarter GDP expoloding by 11.3%, compared to 10.3% in the first quarter, and an official government target of 8%. Here are some figures for the first half of 2006 for China, together with the goverment target (target is bracketed):

Real GDP growth: 10.3% (8% target)
Investment in fixed assets: 31.3% (18%)
Money supply growth: 17.4% (16%)
Trade: 23.0% (15%)
Inflation: 1.3% (less than 3%)

India too, grew at 9.3% for the first quarter, nearly tracking the dragon nation.

China is forecast to continue growing in the medium term in the 7-10% range, while India is forecast also for growth in the 6-9% range.

Finally, a recent report by Scotia Bank economists Warren Justin and Mary Webb indicated that, based on purchasing power parity, newly industrialized Asian nations now account for 30% of global GDP. Even accounting for trade in U.S. dollars, newly industrialized Asian nations account for 12% of global GDP.

And your advisor is telling you to put only 5% or 10% of your portfolio into emerging nations? And you say you're a long-term investor? Really? Then why are you underweighting your portfolio so badly??


JW

The Confused Capitalist

Emerging Market Commentary from the front lines

This is the first (or last, depending on how you look at it), of a trifecta of late day bloggerings today, on the longest day of the year.

I've been reading a blog recently that concentrates on India. In India, apparently by an Indian person. Seems they - financially - have many similar concerns to us here - inflated house and asset prices, etc. In a recent posting, the writer states ...

"While it is not the end of the real estate rally, in general, like any commodities, property prices also go through the boom and bust cycle (in fact, the rise in property prices is not just unique to India!). The reason why we thought it is relevant to highlight the property market to our readers is that even after the fall in the stock markets in the last one and half months, we still hear brokers selling 'real estate' stories to retail investors. While some companies have a long-term strategy to tide volatility in prices, it is pertinent that we, as investors, exercise caution in our judgment. Ultimately, it is our hard earned money!"

In any case, the blog is well worth a visit, if you're considering investing in more than just Indian cuisine.



JW

The Confused Capitalist

Weighing the odds of emerging market outperformance

Well, as sports fans here know, I'm a big fan of many emerging markets, mainly because I consider them to be cheap. For that, you get a good growth profile, better than ever ROEs and current account surpluses - all good stuff. Having said that, all emerging markets are not alike.

A recent UBS report makes many of these same points, suggesting that they offer a good investment profile. As to whether the market continues its' emotional response in the face of further inflationary pressures, or some sort of crisis, is yet to be determined. I suspect that will be the case: in other words, EM market volatility will continue for awhile. I personally hope to profit on this volatility: that in the next plunge, these values will discount at a higher beta than the S&P500.

Yet, the UBS report makes the case that many offer good value, particularly my personal favorite, South Korea.

I suspect that one day off in the not too too distant future (timing, as always Stella, remains the question), the US market and EM market will finally disconnect, with the EM market finally being accorded more respect and lower volatility.

May I suggest you peruse the report?


JW

The Confused Capitalist

It's different this time ...

It's different this time ... that's always the siren call when a market of any sort has gained on, and on, for longer than anyone thought possible.

It was heard at the NASDAQ peak in 2000, and I'm sure in the tulip bulb mania too. While it is a sensible thing to consider - and to remember that more often that not it is a siren song - it isn't always. And I think that the emerging markets phenomenon is one of those cases, where there's a fundamental shift going on, possibly a change or modification to the old world order.

I've made the point several times on this blog that I think the US market in particular appears extended and certainly leading indicators have suggested that the excess liquidity flowing around the world have led to global asset inflation.

A finger is often pointed at the emerging markets, saying that this is a particularly risky market, and it has experienced outsized gains over the past three years, placing its stock valuations on par - in many key ratios - with US markets. This, some pundits say, is clear evidence that the overall market is overvalued and that emerging markets in particular are poised to tumble, when sense returns to the market.

Overall, I agree that many markets are high: I just don't agree that the emerging markets are the clear sign of this. Stock markets are like a reputation: it takes a long time to get one, but once it's in place, many people stop thinking about the market, and consider only its reputation. They start only seeing what was once there. I think this currently provides a benefit to the US markets, and a disservice to many emerging markets.

Many emerging markets have, over the past decade, opened their economies, freed their currencies, and placed their public finances on sound footing. Their companies are more robust than ever before, with modern management (trained in the US in many cases), and robust internal key ratios - like return on capital and equity, earnings growth and cash-flow, and so on. They are, in many instances, true peers to some of the best global corporations - or very close to it.

In the US, on the other hand, there is a very fundamentally deteriorating situation in my view, which isn't properly being valued in the markets:

• Years of underfunding public schools/colleges to provide short-term tax relief;
• A huge overhanging unfunded Social Security liability;
• Fiscal and trade deficits that would make your hair stand on end;
• No one saving anymore - homes are seen as a huge ATM;
• Inflation, which isn't particularly going to benefit the US.
  

Frankly, when I consider all the variables - I see the house above as more emblematic of the current US situation, that I seeing it as an emerging market.

Many people however are conditioned by years when that was clearly an emerging market house, and still see it that way. Me, I'm noticing how nicely some of the other neighborhoods have been fixed up - so to speak - and this one, seems to be running down.

Just an observation - and it's a reason why I'd rather pay roughly equivalent multiples for emerging markets with their significantly faster growth, compared to US markets. Sometimes, some things are different - it just takes awhile for folks to notice it.


JW

The Confused Capitalist

A look at the future? Currency issues.

Well, some of the currency worries are now coming to light and beginning to have a perceptible effect on the markets, as noted in a recent posting at dismally.com, wherein the Swedish central bank publicly stated they'd diminished their reserves of US dollars, in favor of other currencies. This is a trend that can probably only accelerate; one blog (sorry, I couldn't find where I saw this), recently pointed out that the British pound lost 80% of its value as it was replaced as a world currency.

In the interim, the market is still being flooded with liquidity as the Barry Ritholtz at the Big Picture mentions (read as ... "we're cranking up the printing presses, George, as it's the only way out of this pickle").

I've also discussed the effect that the Fed will need to continue rising interest rates, something that'll be needed to protect the currency, and also guard against importing inflation, as the greenback continues its decline against other major world currencies.

In my opinion, these are the early signs of a long future of more of the same, as I've discussed in commentary over here, suggesting that you lock down your adjustable rate mortgages.

The other side of that is, of course, ensuring that all of your own investments aren't denominated in the greenback. This should help "spice up" your returns, as the decline of the USD will aid in boosting returns from foreign stocks and ADRs. This is also part of the reason that well-priced foreign markets will continue to do well for the foreseeable future. While some fret that the mega-returns seen in emerging markets over the past few years is just a prelude to a crash, I don't.

As pointed out in the prior link, many of these emerging economies have moved their public finances to firm footing, their public companies to much more transparent accounting, and their returns on equity are far stronger than ever before. In summary, both the economies and the companies themselves are much more robust than in decades past.

It's my understanding that South Korea is going to be moved out of the "emerging markets" contingent this year - but against that, they still have a very economically-priced stock market, at a 10.5 PE, with projected earnings growth of 15% p.a. for the next two years. Where else can you find a developed country market with these attractive valuation metrics?

Other emerging markets also have attractive valuations too. Against that, the US market offers a relatively high PE, with a very clear deteriorating currency situation possible.

While the over-sized emerging market returns of the past few years may decline somewhat, I think that the overall investing backdrop needs to be considered: Where do you think a rationale investor should park his/her money?






JW

The Confused Capitalist

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When is value, value?

Synonym for Value: Warren Buffett.

My internet friend, Roger Nusbaum, had something to say about value and the perception of value with a recent comment he made. He was discussing a comment that I'd made relating to value or perceived value in some of the emerging markets.

I'd suggested that, in comparison to the S&P 500 - with its' 18 PE ratio and projected earnings growth over the next year of about 10%, didn't necessarily represent good value in comparison to some emerging markets. Particularly Brazil, Korea and Russia, who have projected earnings growth of 11% or better, and PE ratios are below 12. A good combination of growth and value, I thought.

In Roger's comments, he makes a good point that cheap isn't always value, and that many of these markets have traditionally traded at low PE ratios. All true.

However, growth with value almost invariably gets noticed, and the lower risk profile that many emerging markets now have makes for safer investments than in years past. Many of these economies now have good free trade agreements, floating currencies, and generally more stable economic situations. In my opinion, this is part of what is leading investors to willingly pay more than ever for emerging markets: lower risk and a superior growth profile.

The inverse is of course true for the US market, with its continued burgeoning trade and fiscal deficits. If these trends continue, not only will the US currency continue its' descent, but even its' markets will eventually be revalued lower.

Cheap isn't necessarily good, nor is expensive wonderful. It must all be considered in its' rightful context: value.

"Price is what you pay - Value is what you get."

Warren Buffett


JW

The Confused Capitalist

Emerging Markets: Head for the Hills?

I haven't read the full results of the Morgan Stanley report entitled Head for the Hills but, apparently in their view, emerging markets are poised for a slump, after several years of strong gains.

This is of course, completely contrary to what I recently reported wherein State Street Global Advisors considered emerging markets to be valued similarly to three years ago. Should we rank these varying sentiments according to the number of employees of each has? Morgan Stanley has about 53,000, while State Street has about 20,000.

So give a 2:1 preference ranking to Morgan Stanley? Perhaps not that good a way to resolve this conundrum?

That's the reason we have a brain I suppose (to weigh opposing opinions), and diversification in our portfolios. I suggest, that you not panic and "Head for the Hills" (nice alarmist statement, guaranteed to churn accounts), and simply review your portfolio to see if you are comfortable with your weightings. It's as simple as that ...


JW

The Confused Capitalist