Between 1950 and the end of 2013, one US dollar invested into developed country stock indices would have grown to $640. The same dollar invested into emerging markets would have grown to $1,670, or 2.6 times as much. But emerging markets have been largely out of fashion since 2011. So, has everything changed? And which are the best stock markets to invest in today?
Once a year investment bank Credit Suisse produces a fascinating report, along with London Business School, called the Global Investment Returns Yearbook.
What’s unusual about this report, and hence highly valuable, is that it analyses historical stock market return data going back to 1900, and across many countries.
Most people think being a successful investor is about learning complex valuation formulae and knowing how to analyse a set of company accounts. Indeed, those are extremely useful skills.
But you’re unlikely to become a truly successful investor – at least not for long – unless you’ve studied the history of the field. Technology and financial industry jargon may change over time, but human nature doesn’t.
By looking at history we can derive important insights into how to invest today. For example, we can look at speculative bubbles and financial crises, and what caused them. Even better than that, we can analyse what kinds of investment strategies have been most consistently successful in the past.
In the interests of space, I’ll only be able to highlight a few of the main findings from the Credit Suisse analysis in this article.
So, let’s dive into what they have found out. First up, here’s a graph showing the performance of developed market stocks (in blue) and emerging market stocks (in red) between 1900 and 2013.
Throughout the data set new countries are added from the first years that data are available. Also, many countries that started as emerging markets were later reclassified as developed markets, as they became wealthier and more advanced.
(Note: the chart has a log scale, which means that as you move from left to right the same rise or fall on the vertical scale will look the same to the viewer. So a 10% rise or fall in 1900 would look the same as a 10% rise or fall in 2013.)
Essentially there are three periods on the graph. From 1900 to 1945 the emerging markets and developed markets performed the same overall, although not at the same time. That’s four and a half decades where emerging market performance was neck and neck with developed markets, measured in US dollars.
Then from 1945 to 1949 you can see a sharp divergence as the emerging market line falls off a cliff. The main drivers of this were a 98% collapse in the Japanese market – then classified as emerging – after the second world war and the 100% loss to investors in Chinese stocks, when the market was closed following the 1949 communist revolution.
After that, between the start of 1950 and end of 2013, the emerging markets significantly outperformed, returning an average 12.5% a year versus 10.8% a year in the developed markets. The result, with profit compounding, was that investors in emerging markets would have made 2.6 times as much money, before taxes.
So the last 64 years have been strong for emerging markets. It’s easy to lose sight of this with the recent price underperformance of emerging market stocks in relation to developed market ones, especially against the US.
Over the whole period we have 45 years where emerging markets were neck-and-neck with developed ones, 5 years of collapse after world war two, and 64 years of catch up.
Of course there has been long periods of divergence. In the 1990s emerging markets underperformed as investors became over-excited about technology companies. Then in the 2000s the situation was reversed, as the tech bubble burst and emerging market economies grew much faster than developed ones.
I believe that, in the long run, many emerging economies will continue to be the faster growing parts of the world. Most of them have younger and faster growing populations than the developed world. That means there are more people with money to spend each year.
And even those that don’t have those kinds of positive demographics, such as China, will still benefit from growing productivity. A large part of this is being driven by urbanisation, as people move off the land to seek work in cities and towns. The work is often more specialised, meaning wages are higher, meaning more disposable income. Plus cities are notoriously full of tempting ways to spend money, unlike living in the middle of nowhere.
So faster growing populations and/or rapidly increasing productivity are the twin engines of emerging market economic expansion. This in turn drives higher levels of consumption, as more people have more money to spend, which drive company profits.
So I expect companies that make most of their profits in emerging markets to benefit the most from this growth. And most companies that fit that bill are also from emerging markets, operating in their home markets.
And if that doesn’t convince you then just take a look at stock market prices today. The MSCI Emerging Markets index had a trailing P/E ratio of 12.3 at the end of March. On the other hand the MSCI World index of developed country stocks had a P/E of 17.5, which is 42% higher. In other words you currently have to pay a big premium to invest in developed markets with lower growth and higher debt levels.
When it comes to investing it’s easy to be distracted by daily news blurb, marketing speak, current fashions and recent price performance. But given the historical track record, better fundamental conditions for economic growth, and lower current valuations I have no doubt that I’d prefer to park my wealth in emerging market stocks than developed market ones.
I suggest that fellow OfWealthers do the same.
Stay tuned OfWealthers,