Stocks and Shares

Where to find growth AND value in today’s markets

Developed market stocks are mostly expensive. Emerging markets mostly aren’t.  Developed countries are mostly structurally low growth economies. Emerging market countries are mostly higher growth. Conclusion: buy emerging markets for both value and growth. Today I have some extra evidence.

Earlier in the week I presented “Seven charts that show why EM stocks will outperform”. Shortly afterwards I was rooting around on my computer and found more charts that add weight to the idea. At least they do when sprinkled with a dash of analysis.

These days, practically nobody would believe me if I just said: “Emerging market stocks have beaten US stocks over the past three decades”. So, as a reminder, here’s the chart of performance of MSCI indices since 1987 that shows just how well they’ve done (see the above link to the previous for a full explanation).

What this shows is that $100 invested in the MSCI Emerging Market index in December 1987 would have turned into about $2,100 today, including reinvested dividends and before taxes. That works out at about 10.9% a year, with compounding (profits on profits).

What’s more, emerging market stocks are pretty cheap. The P/E of the MSCI Emerging Markets index is just 15.2, against 24.1 for the MSCI USA (and 25.3 for the S&P 500 index). That’s a 37% value discount, despite emerging market companies being based in faster growing economies.

But here’s another measure: the price-to-book ratio (P/B). “Book value” is also known as shareholders’ equity or net asset value (NAV). It’s all a company owns (assets) less all it owes (liabilities). In other words, barring some embedded accounting inaccuracies, it’s an approximation of liquidation value. Most stocks trade well above book value most of the time, assuming they’re the stocks of sufficiently profitable and growing companies.

Cheaply…or at least reasonably…priced

At the end of April the MSCI Emerging Markets index had a P/B ratio of 1.6, compared with 3.1 for the MSCI USA. What’s interesting about that is that it’s well below average. At least well below the average of 1.8 since 1995, according to this slightly-out-of-date chart which runs up to March 2015.

(Unfortunately I can’t remember where this chart came from two years ago. But I’m pretty sure it was a piece of research from one of the big investment banks.)

Arguably the average was dragged up by over excitement during the 2005 to 2008 period (do you remember the “commodities super cycle”?). But on the other hand there were notable low points, including during the Asian crisis in 1997 (followed in 1998 by the Russian crisis), and things were hardly peachy in late 2000, 2002 or 2008.

The point is that emerging market stocks are reasonably priced today, and probably slightly on the cheap side. Of course, not every country is a bargain, let along every stock. Places like India, Indonesia and the Philippines find themselves at the pricier end. Russia, China and South Korea find themselves at the cheaper end. Russia is a particular bargain, and a great performer historically (see “The hated stock market that beats the USA” for more).

(Arguably South Korea, along with Taiwan, shouldn’t really be thought of as “emerging markets”. They’re already too wealthy and developed. But these two countries are still classified that way by most people in the investment world, including by MSCI.)

Next I’ve got an even longer chart of performance history for emerging market (in red) and developed market (in blue) stocks. It runs from 1900 to 2013 inclusive, which is 114 years of data. This came from the Credit Global Investment Returns Yearbook 2014.

One (US) dollar invested in developed market stocks at the start of 1900, with dividends reinvested (and zero tax), turned into $9,199 by the end of 2013. In the meantime a dollar invested in emerging markets turned into $3,387.

The compound annual rates of return were 8.3% a year for developed markets and 7.4% a year for emerging markets. That’s a difference of just 0.9% a year. But the end result is 2.7 times better for developed markets. This is a great example of the long term power of compounding in action. Small differences reinvested over long periods of time make a big difference to end results.

64 years of outperformance

Therefore the evidence appears to show that developed markets were the best place to be. But a closer look at the chart shows a more nuanced story. Here’s the same chart again, but I’ve added some annotations.

Both developed and emerging market stocks had similar overall performance between 1900 and 1945, returning around 5% a year. That wasn’t much, but it did include episodes such as the Great Depression.

Then there was a massive collapse of emerging markets between 1945 and 1950, in the period after the second world war. The biggest cause of this was a 98% fall in Japanese stocks (in this time series Japan was classified as an emerging market until 1967). Also there was a 100% loss for investors in Chinese stocks. That was after the 1949 communist revolution led to the confiscation of property.

But then began a period of recovery for emerging markets. In fact they significantly outperformed from 1950 to 2013, returning an average of 12.5% a year, compared with 10.8% a year for developed markets. That’s a considerable 1.7% a year extra.

A dollar invested in developed market stocks in 1950 turned into $709 by the end of 2013. Meantime a dollar in emerging markets turned into $1,878, or 2.6 times as much over 64 years.

As I explained last time (click here) long term stock market outperformance by a set of countries always comes down to faster economic growth. That’s despite confused analysis and false claims made by many people that economic growth doesn’t matter for investors in stocks.

Different people want different things from their stock market investments. Some investors search for rapid growth. Others look for value, meaning what they buy is cheap. But if you can have both then so much the better. I believe emerging market stocks offer just such a combination at this time. Make sure you own some.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.

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