One of the most dominant themes prior to the financial crisis was the great convergence of global markets. Bond markets seemed to synchronize around a “global” rate regime and stock markets seemed to synchronize around “global” growth rates. What began with the disaggregation of European bond yields has now spread across asset markets as well.
Buyers have begun differentiating asset class components and applying more micro scrutiny. This disaggregation makes fundamental analysis pleasantly relevant again. The unbundling of the emerging markets is perhaps the most interesting story developing today.
The term “emerging markets” didn’t even exist until Antoine Van Agtmael coined the phrase in 1981. At that time the emerging markets he referred to represented approximately 15 percent of global GDP.
Today the emerging markets economies account for nearly 50 percent of global GDP. The MSCI Emerging Market stock markets index didn’t appear until 1988. At that point the emerging markets accounted for less than 1 percent of global stock market capitalization. Today they account for 12 percent of global stock market capitalization. $100 invested in the emerging market index in 1988 became $1,326 through July 31. $100 in the G7 (largest developed economies) became $350. No homework necessary!
Today, the emerging markets have emerged. Brazil, Russia, China and India now rank within the top 10 largest global economies. Investors do not trade the “developed world” monolithically because they understand the nuances between the USA, Japan, Germany and the UK.
As investors become more aware of the nuances in the “emerging world” country differentiation will occur there as well. Currently, the more hawkish stance of the U.S. Federal Reserve has put a cloud over the emerging market complex. Should U.S. interest rates rise, the incentive to lend to higher yielding foreign markets diminishes. While the collective emerging market indices have declined, the country specific indices exhibit differentiation.
Since the Fed began its tapering talk in May, emerging market countries with large funding deficits have been pummeled. Turkey, Indonesia and India, large importers of capital, have fallen more than 20 percent over the last three months. China, South Korea and Russia who actually export capital have fallen less than 3 percent over the same time period.
As the emerging market component countries continue to differentiate themselves to investors, the opportunities for active managers abound. Indexing the emerging markets worked well when they moved as a group from obscurity to celebrity. Increasingly the component countries trade on individual merits. Homework required!
At W&A, we remain optimistic about the valuations and return opportunities scattered across the emerging markets. Marketplace disruptions like the one currently plaguing the deficit countries present opportunities. Investors utilizing managers with a free hand to sift these markets are well-positioned. Being tied to an index that trades the emerging markets as a class blindly subjects investors to a plethora of avoidable risks. Do not confuse the negative monolithic comments in the media regarding the emerging markets with the opportunities they provide for more discerning investors. Differentiation is a welcome divergence.
David Waddell, who is regularly featured in the Wall Street Journal, USA Today and Forbes, as well as on Fox Business News and CNBC, is president and CEO of Memphis-based Waddell & Associates.