Top fund manager David Herro thinks emerging-market stocks remain overpriced, but he thinks there is a way for investors to benefit from emerging market growth.
David Herro has been one of the top fund managers in the world for over a decade, and he says emerging markets are looking overvalued even after recent declines.
Templeton Asset Management’s Mark Mobius says he thinks the emerging market trouble that has seeped into the U.S. market a bit will be temporary, and will provide significant buying opportunities. Mobius tells CNBC that there’s “no good reason” for the EM declines, which appear to be the result of fears that money will flow out of EMs as the Federal Reserve tapers its quantitative easing program. He notes that emerging market central banks’ balance sheets in general remain far better than those of the U.S. and other developed markets. He does say that balance sheets of American corporations are very strong, and he expects to see a pick-up in U.S. capital spending, which he thinks will benefit emerging markets.
Emerging markets can make for enticing investments, and new research from James O’Shaughnessy’s firm shows how fundamental-focused investors can really take advantage of EM opportunities.
“U.S. investors, and other investors around the world, tend to overweight their home country in their equity portfolio,” write O’Shaughnessy Asset Management’s Patrick O’Shaughnessy and Ashvin Viswanathan in a report available on the firm’s website. “By doing so, they miss out on considerable investment opportunities abroad.” They say that emerging markets are compelling for three key reasons right now:
- home bias, which has meant that many U.S. investors “have little to no direct allocation to emerging market equities”;
- valuation (emerging markets trade at a 31% discount to U.S. stocks using the 10-year cyclically-adjusted price/earnings ratio);
- “huge mispricings” that are the result of less attention among analysts and less scrutiny for EM firms’ financial statements
That last point makes EMs fertile ground for fundamental-focused investors, O’Shaughnessy and Viswanathan say. They looked at stocks in the U.S., other developed markets, and emerging markets from 1995-2012 to see how those that rated highest using OSAM’s fundamental stock-picking factors fared vs. market averages. They found that in the U.S., the top decile of stocks using a Momentum Composite outperformed the broader U.S. market by 3.3% annualized. Those in the top decile based on dividend yield outperformed by 1.3%, while those in the top decile based on OSAM’s Value Composite outperformed by 4.7%. In other developed markets, the outperformance was greater (6.8% for the high-momentum stocks; 8.7% for high-dividend stocks; and 9.2% for best-value stocks).
In EMs, the outperformance was all in all still greater. High-momentum stocks outperformed the broader EM market by 6.6%; high-dividend stocks did so by 10.6%; and best-value stocks did so by 11.9%. They found that within all the individual EM countries they examined, the outperformance also occurred.
“The important point is that while these factors work everywhere, they work best in what we would argue are the least efficient markets,” O’Shaughnessy and Viswanathan write. “We believe these factors are immune to socio-economic and political idiosyncrasies because they are driven by human nature. In every country, unloved stocks have been left priced too cheaply, allowing a valuation-based strategy to thrive.”
While EMs come with their own unique sets of risks and often have higher volatility than developed markets, OSAM concludes that investors would be wise to use a portion of their portfolios for fundamentally sound EM stocks.
Emerging markets guru Mark Mobius says he is finding global valuations “rather cheap”, and says he is finding a number of attractively priced stocks in Europe, Southeast Asia, China, and Africa.
“Looking at companies around the world generally, we are finding that valuations look rather cheap right now,” Mobius says in an interview posted on Franklin Templeton’s website. “The price-earnings ratios of emerging markets averaged about 9.6 ( based on the MSCI Emerging Markets Index 12-month forward P/E), compared to a world index of 11.4 (based on the MSCI World Index 12-month forward P/E) and the U.S. average of 11.9 (based on the MSCI US Index 12-month forward P/E), as of July. The dividend yield average for emerging markets was 3.0%, while the world average was 2.9% and the U.S. was 2.2%, as of July, based on the MSCI EM Index, World Index and US Index. So, as value investors, our team has been finding lots of opportunities in these markets that we think should bode well longer term.”
Mobius says one area in particular that appeals to him is Eastern Europe. “We are finding a lot of the opportunities there from companies where valuations have dramatically wiped out, many unfairly, and provide opportunities for long-term holdings,” he says, adding that he thinks the European debt crisis “should get better with time”. He also thinks that, while China’s growth may slow, there are a number of very attractive individual companies there. And he’s also high on firms in Southeast Asia and Africa.
PIMCO’s Rob Arnott says a major demographic shift means bad news for U.S. markets in the coming decades, though he says smart baby boomers will still be able to hit their retirement goals within a year or two of their original plans.
Arnott tells The Wall Street Journal that this is the first year ever in the U.S. that the population of senior citizens will rise faster than the working-age population. Less than ten years ago, he says, 10 new workers were added to the population for every new senior citizen. “It goes to 10-to-1 in the opposite direction in 10 years,” Arnott says. “There will be 10 new senior citizens for each new working-age citizen. If that’s not a political, economic and capital-markets game changer, I don’t know what is.”
Arnott says that, combined with the debt and deficits facing the U.S., will combine to create “anemic” investment returns of about 5.5% to 6% for stocks. If bonds return 2% to 4%, he says, that makes for an overall average of about 4% returns per year for a portfolio — before taxes and inflation. “Net of inflation and net of taxes, that’s awfully close to zero real after-tax return,” he says.
Still, Arnott says he’s not talking about a “doom-and-gloom scenario”. Instead, he says, “What I’m painting is a scenario that is challenging, that’s difficult. Compared with the ’80s and ’90s, it is awful. But the ’80s and ’90s were an extraordinary period.”
Arnott also explains why he thinks emerging markets are a much more attractive area than the U.S. for investors, both in terms of bonds and stocks. And, he says, they may also be safer areas than the U.S. markets. “It’s really simple,” he says when asked to give his advice to baby boomers. “Save more aggressively; invest in economies that aren’t afflicted by the 3-D hurricane of deficit, debt and demography; and diversify into markets that can serve us well in a reflationary world.”