Indonesia, Malaysia, Philippines, Thailand, Vietnam 4.9%
…and as we know asset managers in the developed world will be saying – “The developed world remains the ‘engine of growth’, while developing world slows, thus we recommend piling into the cluster which are US/JP/UK equities, as these valuations still look attractive. Please just ignore the highly experimental monetary policies, propped up growth rates, unreasonable equity market valuations, and financial engineering…it will be fine, as long as you keep us propped up.”
Jerome Booth absolutely nailing it in this interview.
Global asset allocation is currently irrational; ignoring basic macroeconomics, with a view of risk/return that is flat out wrong. Everyone avoiding the “risky” 4-7% growth countries, while piling into the overvalued low-growth manipulated-market “safe” countries. This increases risk, not decreases it as the people making this trade think.
The growth can be there and the equities still be overvalued. It’s been a long time since I tried valuing EM indexes so I’m not really sure where they are, but arguments about EM that are built solely on the idea that they are going to grow faster than DM are extremely suspect.
Workers in DM may still be screwed, but DM companies can still do quite well, and even better if they are internationally exposed. EM companies may not end up fully benefitting from all that growth in an investible sense if DM companies in EM locations eat their lunch for them.
It’s also not entirely clear how much of EM growth is due to credit expansion similar to what we’ve seen in the US. If so, there’s a point, where that becomes a risk not unlike it did here in 2006.
So yes, EM is a place to be active, but the case doesn’t begin and end at higher expected growth rates. Things can still be overvalued and therefore a bad investment even if the growth projections are reasonable and accurate.
Of course, but the point is managers are ignoring the entire non-developed world as a category , without doing any research or thinking for themselves, “because develped world is safe” (not true). There are many countries out there, some indexes like India’s NIFTY are already trading quite high and have high growth priced in, others are high growth and cheap. But DM is low-growth and expensive, the worse possible combination. If this “low-growth DM is awesome” thesis goes wrong those people aren’t diversified.
The fact is China, India, Philippines, Indonesia and many others have massively outperformed the developed world over the last 10 years (index returns, not looking at currency), so none of that “DM eating EM’s lunch” has actually worked out. Heck even Brazil’s 10yr price return is tied with S&P500. And there’s really no reason why that trend doesn’t continue; EM slows down slowly over time, but DM does too (requiring more and more desperate stimulus to hit 1-2% growth, which increases risk).
You missed my point. I don’t have a strong opinion on EM right at this moment, though I do think they are more closely coupled to the fate of the developed world than you do, but I do know that an argument that we should be invested in EM just because the GDP is going to grow faster than the US and Europe (and Japan’s) is not enough on its own to make the case. And if the other argument for EM is a version of performance chasing, that doesn’t seem very promising either.
I’ve been a fan of EM at various points over the last 15 years, but things don’t look so great right now in a lot of places. There are also liquidity considerations to be made, especially if you’re managing large funds.
Dude I have a perfect index for you (ignoring currency).
Check out the returns on this bad boy over the last few years! Just have to ignore currency, political, social, and capital control risks and you’ll be retiring in no time bro!
The fact is, everything starts with macroeconomics, country-picking, then you pick stocks. But industry practitioners and totally ignoring this step. That’s my point, and it’s true, as you yourself admit you have not reviewed opportunity cost. People simply have not done their work, and offer rationalizations for that.
You say that GDP growth is not a enough to make a case (as if someone is stupid enough to blindly sort by GDP growth and invest there), and that we shouldn’t study past correlations (as that is “performance chasing”). Clearly long-term GDP growth is highly correlated with long-term index returns, and yes it’s going to be that way in the future too. And this nonsense of “but if DM goes down EM will go down” doesn’t make sense either – assets are correlated, see 2008, and yet high growth EM continues to outperform over the long-term despite this (see China and India), so what’s the point again?
Cmon guys, this is basic CFA stuff, and everyone is ignoring it – country pick, sector pick, stock pick. Do your work.
^CFA materials indicate that EM provides very good diversification benefits.
I agree with purealpha; most investors who mainly rely on domestic indices are going to be very disappointed with the returns they’ll earn in the next decade. Advisors will likely have to readjust their asset allocation to include a larger share of EM.
The IMF forecasts for the developed world actually look stronger than what I read elsewhere in some reports from GM; they expected about 2% for the next few years for the US.
With some emerging markets, many of the components are traded as ADRs as well as in the domestic market.(Brazil and Bovespa was the market I watched recently). I am aware that there is strict correlation between the ADR and the domestic shares HOWEVER does one version do the leading? I am sure the influence goes both ways but is there more of ADR traders looking at how the equity is trading on its local market or those soverigne traders looking at how the ADRs are behaving? I realize that everyone is theoretically trading on the same news and catalysts BUT, I imagine there is a loss of pricing efficiency if the ADRs have the uppper hand in influence.
Back to my example of Brazil, with the “coming clean” on operation car wash (Petrobras), the entire Brazilan index rallied for a couple months even though every prediction on the perfomace of Brazil as a country was bleak. Judging by the comments on seeking alpha by amatures, there was A LOT of people buying into this rally who did not really know the situation. There was something lost in translation fom Brazil… to what gets reported to those trading the ADRs. It is a slight difference, but the deduction in price effeciency, if ADRs lead the way, could be a legitamate factor when dealing with emerging market equites, don’t you think?
My understanding is that the CFA curriculumn says “Indexing (with a suitable asset class allocation) is not a bad idea and should be your baseline scenario in the absense of strong [informed] convictions.” I.e. Indexing works pretty well over the long term, and one could easily do worse by not indexing.
The CFA curriculum is more agnostic about the possibility of outperformance vs the index, and lets exam takers come to their own conclusions about whether it is worth digging through balance sheets and cash flow statements to outperform the index. The year I took Level 2, they had the Treynor model (and a godawful PM vignette using it), which would be something completely irrelevant to the curriculum if one assumed that generating consistent alpha were impossible. They also taught the Black-Litterman model in L3 when I took it, which would be irrelevant if you didn’t think alpha was possible.
When I took the CFA exams, the curriculum seemed to be pretty firm that technical analysis was unlikely to work. I always thought that was dismissed a little too easily, and still believe that technicals do inform peoples perceptions of risk in ways that are meaningful to valuation.
With ADRs, there is a difference related to time zones, particularly with Asia and Europe, less so with Brazil, because market hours overlap. I am sure that some investors try to arbitrage the difference between local markets and ADR markets and that keeps the prices from drifting too far apart, but the arbitrage isn’t perfect unless you can buy and sell the ADR, the local issue, and the currency simultaneously. Otherwise you get basis risk because the prices can change when one market is closed but the other is open.
Whether one leads or not probably depends on the liquidity both on the supply side and the demand side. I haven’t worked with them in a while, but would think that in EM markets that are not Frontier Markets, the market value of ADRs is probably a fraction of the domestic market value and therefore is not likely to move the needle that much. On the other hand, if the investment capital wants exposure without crossing borders, it’s possible that the capital that uses ADRs to get exposure will behave differently than the local sources of capital, and so you could get a push and pull of two different supply/demand dynamics.
Yes I would say it’s mathematically difficult to show a base case where developed world (starting from these sky high valuations) doesn’t underperform over the next 10 years vs a properly weighted emerging market index. However, because the developed world sets the benchmarks, they manipulate the bench to be easier for them to beat… See EM benchmark pie chart below, 1) KR is not EM but they give its low-growth economy a 16% weight?, 2) CN is never weighted properly and doesn’t even include the real A-shares which have massively outperformed historically, and are now available to foreigners, 3) Taiwan is half the weight of China??, 4) Brazil isn’t even on the chart, perhaps in other, 4) India is only 9%. I’ve built custom benchmarks as my job before, and this is called manipulation, plain and simple. https://www.msci.com/resources/factsheets/index_fact_sheet/msci-emerging-markets-index-usd-net.pdf
Yeah 2.8% US growth rate seems suspicious. We keep hearing how GDP and earnings growth is just around the corner, yet it never arrives. A 2% target is more reasonable.
This is indeed a HUGE deal, and it’s because there are three versions of the news 1) what the developed world receives, 2) what the local market receives, and 3) what is really happening. On top of that you have a different investor base in each country, which values different things. And of course time zones (Westerners just waking up do not have time to analyze new information and they react blindly, see Aug24).
Not just ADRs, but also index ETFs can drift way off NAV. I’ve done a number of trades on that this year, also selling overpriced put/call options to people in DM who don’t understand what is really happening. The information in the “informations age”, is garbage.
No matter your view of DM/EM, there is a shit ton of mispricing out there to be exploited.
^^^PA, I’m glad you post in AF. There are many very knowledgeable people on this forum, but this stuff is most powerful when filtered though an original mind.
LOL, dude I have zero knowledge on Africa or how/what to trade there, I looked at it for like 10min awhile back but couldn’t make any sense of it.
My IB buddy who is always flying around the globe making deals in obscure places – says UAE is the hot stuff. I guess there’s all sorts of stuff happening there, and we outsiders just don’t hear about it. Again, a news feed problem. The Abu Dhabi Securities Market General Indexseems fairly cheap at 11.9X trailing P/E…but who knows anything about it or what goes on in that country? Not me.
Regarding the ADR discussion…Bloomberg just came out with an article on ADR pricing. “The Bloomberg U.S.-China equity Index…trades at 8.1 times reported earnings, less than half of the multiple for the Shanghai Composite.” I guess these names keep getting buyout offers, which suggests something is priced wrong. Guessing due to bearishness of US investors.
