Economic News & Analysis—February 14, 2014
Emerging markets: Near the point of maximum pessimism?By Brian Jacobsen, Ph.D., CFA, CFP®, Chief Portfolio Strategist
The famous investor and philanthropist Sir John Templeton said, “Invest at the point of maximum pessimism.” That might be where we are with emerging markets stocks.
When investors talk about the emerging markets, you need to ask which countries they’re referring to. I generally use the MSCI list, which does not include Argentina or Ukraine, which are hotbeds of problems. For emerging markets where U.S. investors can actually invest, I think companies are looking pretty cheap, and it’s likely too late to try to underweight them. The trickier and more relevant question than what has happened in the emerging markets is what will happen?
From a valuation perspective, the emerging markets complex is at a 33% discount relative to the S&P 500 Index. For perspective, in 2007, it was at a 13% discount. Political issues in Argentina, Turkey, and the Ukraine are tarnishing the other emerging markets countries.
The changing composition of the emerging markets indexes
Investors aren’t just paying for growth, they are also getting income
In terms of country exposure, the index has also changed over time. This highlights why I think investors should be careful about blindly following an index. In the MSCI Emerging Markets Index, the largest country exposure is China, at 19.76%. Don’t get me wrong, I like China as an investment destination, but a lot of the index exposure is in China’s banking industry, and I don’t have an optimistic outlook for that industry. I’m more optimistic about telecommunication services, industrials, energy, consumer staples, consumer discretionary, and health care (pretty much everything except banks and materials).
Positive changes in most, though not all, emerging markets countries
There will always be risk. Investors should ask themselves if they can identify the risks, if they can understand the risks, and if they are paid to own the risks. The currency and political issues are identified, understood, and well compensated in quality companies. Quality means companies that have good corporate governance and consistently generated operating cash flows. A lot of those companies are out there, but you have to dig through a bit of rubble to find them.
Bottom line? When investments are on sale, I think it’s time to start increasing, not decreasing, exposure.