The Case for Emerging Markets

Transcription

1 The Case for Emerging Markets In Breakout Nations, Richard Sharma writes The old rule of forecasting was to make as many forecasts as possible and publicize the ones you got right. The new rule is to forecast so far into the future that no one will know you got it wrong. As financial advisors responsible for making daily investment recommendations, we have the luxury of neither alternative. And while we do our best to avoid making specific forecasts, we work diligently to develop economic themes, and to identify specific investment opportunities that capitalize on these themes and, we believe, best serve our clients investment goals. This process has shaped our current view on emerging markets. Emerging markets are loosely defined to include countries that have an established stock market, growing and industrializing economies, and a growing middle class with per capita income typically less than $5,000/yr. These markets have grown in size and liquidity to the point that they have attracted international investors. MSCI, the world s largest developer of financial analysis tools and indices, includes 21 countries in its MSCI EM (Emerging Market) Index. The largest seven include the BRIC countries (Brazil, Russia, India, China) as well as Mexico, Indonesia and Turkey. Another 25 countries are included in the MSCI FM (Frontier Market) Index. These markets are in very small nations at an early stage of economic development. Larger frontier markets are sometimes grouped into the emerging market category. Emerging markets are recognized for their economic growth. This growth is typically the result of urbanization and industrialization. McKinsey and Company estimates that in China alone, more than 300 million people will migrate from farms to cities by the year In India, another 250 million will migrate by If managed properly, urbanization leads to higher productivity in a country, as more people join the work force. Shown below is a comparison of industrial production in emerging economies versus advanced economies. Since the year 2000, advanced economy production is about the same. However, total industrial production in the emerging economies is two and half times the 2000 level. 1

2 Increasing productivity drives growth in Gross Domestic Product (GDP). As seen below, GDP growth has been, and is expected to be, much higher in the developing world.

3 Consistent with J.P. Morgan s forecast, the International Monetary Fund (IMF) expects GDP to grow 5.3% in the developing world during 2013, but only 1.2% in the developed world. The IMF forecasts another 5.7% growth for emerging markets in As GDP in any particular country increases, domestic consumption (consumer spending) follows. In 2002 the United States consumed approximately 37% of the world s output, compared to just 23% for the combined emerging market countries. In 2010, the US consumed approximately 27% of the world s output, while the emerging market share jumped to 34% 2. This trend continues. As more goods and services are sought by consumers in emerging markets, more companies will be there to provide them. In the year 2000, emerging market companies represented approximately 5.5% of Global Market Capitalization (value of all public companies). In 2012, this share had risen to more than 12% 2. Companies that are well-positioned in emerging markets will have the opportunity to take advantage of this market growth. Increasing sales, and especially increasing profits, bode well for investors. However, investing in these markets includes the typical company and market risks, as well as additional risks unique to developing markets. Unique risks include political instability, lack of market liquidity and transparency, and shifts in foreign currency values, just to name a few. In general, emerging market stocks tend to be more volatile than those in developed countries.

4 In our opinion, given a balanced view of both the risks and the opportunities, emerging market investments deserve an increasing portion of investment portfolios for suitable investors. In addition to the longer term reasons outlined above, we also believe that emerging market stocks are attractively priced right now. Over the last two years ended April 30, 2013, the S&P 500 index has risen by more than 17%, while indices tracking emerging market economies have been down in the double digits. As shown on the two slides below, this wide difference in returns has contributed to a significant discount in the overall price of emerging market stocks, as compared to US stocks. The first slide shows various measures of stock prices in the developed world. Perhaps the best measure is the Forward Price/Earnings (Fwd. P/E) ratio, as shown towards the bottom left of the exhibit. This ratio depicts the average stock price for $1 of earnings expected in the next 12 months (from 3/31/13) the higher the ratio, the more expensive the average stock. The United States ratio is 13.9, which is comparable to its 10 year average. The next slide tells a different story for emerging markets, where prices are generally lower. For the emerging markets as a whole (EM Index), the Forward P/E is 10.6, which is a discount of approximately 7% from its 10 year average and a 24% discount from the US. While some discount can be expected given the unique risks presented by emerging market equities, we believe the current discount is excessive and will reduce over time. That, combined with anticipated higher growth in profitability, leads us to believe the emerging market equities should perform well over the longer term.

5 So how do we invest in emerging markets? We cannot purchase stocks directly from a local exchange, nor do we have the infrastructure in place to research local companies. There are many choices out there, and we constantly monitor the available investments with the goal of identifying those that will best serve our clients. There is another way to invest in emerging markets. Today, economies are more interconnected than ever before we now live and participate in a global economy. In 2012, more than 35% of the total sales of the top 200 US companies were made outside the US 2. A sizable portion of these sales were in emerging markets. We research and invest in US companies that are present and growing in emerging markets. These well-managed, dividend-paying, blue chip multi-national companies give us indirect exposure to emerging markets with considerably less risk. This is a running theme in our office; one which we believe will serve us well for years to come. Investing in emerging markets comes with significant risk, which is why exposure should be limited in any given portfolio. Developing countries face daunting challenges, and many (or most) may not reach their full potential for generations, if at all. But in a suitable portfolio, emerging markets provide diversification and the potential for strong returns.

6 One final thought: In the short term, markets trade on emotion. Over the long term, markets trade on fundamentals. In our view, the fundamentals support investment in emerging markets. Steven Criscuolo, CPA Financial Advisor [1] Ed Yardeni. www/yardeni.com [2] J.P. Morgan Guide to the Markets 2Q/2013 The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Steven Criscuolo and not necessarily those of RJFS or Raymond James. Expressions of opinion are as of this date and are subject to change without notice. Investing involves risk and investors may incur a profit or a loss. Every investor s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. The opinions and services of McKinsey and Company are independent of Raymond James. Investments mentioned may not be suitable for all investors. There is no assurance that any of the trends mentioned will continue in the future. Past performance is not indicative of future results. Diversification does not ensure a profit or guarantee against a loss. Dividends are not guaranteed and must be authorized by the company s board of directors. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transactions costs or other fees, which will affect actual investment performance. Individual investor s results will vary. Raymond James Financial Services does not accept orders and/or instructions regarding your account by , voice mail, fax or any alternate method. Transactional details do not supersede normal trade confirmations or statements. sent through the Internet is not secure or confidential. Raymond James Financial Services reserves the right to monitor all . Any information provided in this has been prepared from sources believed to be reliable, but is not guaranteed by Raymond James Financial Services and is not a complete summary or statement of all available data necessary for making an investment decision. Any information provided is for informational purposes only and does not constitute a recommendation. Raymond James Financial Services and its employees may own options, rights or warrants to purchase any of the securities mentioned in . This is intended only for the person or entity to which it is addressed and may contain confidential and/or privileged material. Any review, retransmission, dissemination or other use of, or taking of any action in reliance upon, this information by persons or entities other than the intended recipient is prohibited. If you received this message in error, please contact the sender immediately and delete the material from your computer.