Many things have changed since I began as a fund manager in 1995. My bosses flew Concorde and we could smoke at our desks after 6pm as we pondered what to buy with our car allowance.
But so much more has stayed the same. When it comes to investing, US companies still trump all comers. Europe muddles along, as ever. And of course a new century dominated by emerging nations is due any second now.
When I say “just around the next corner” my children immediately assume the pub is miles away. So how anyone has managed to keep a straight face selling emerging market equities is one of the mysteries of finance.
Aside from a seven-year stretch beginning in 2002, developed market stocks have trounced them pretty much my whole career. So relentlessly dire have relative returns been, especially post-financial crisis, that when the word “emerging” is spoken, all I hear is a gurgling noise.
My ears have unblocked recently, however. First, because I’m conscious that beyond Asia and India my portfolio doesn’t have a penny in another emerging market (as defined by MSCI).
No Latin America, Africa, nor all those places in central Europe you backpacked through after the Berlin Wall came down because they were basically free. That’s 15 per cent of the world’s 70,000 public companies, according to my Capital IQ database.
Second, I’m a contrarian. Global inflows into emerging market funds since January are 30 per cent down on this point last year, according to LSEG Lipper estimates, which in turn were two-thirds lower than 2021.
Then on Monday along comes Ruchir Sharma, chair of Rockefeller International, who wrote in this newspaper that “a major comeback is under way” and investors have “yet to respond”. He was persuasive.
To summarise, emerging economies are outpacing developed-world ones on an output per capita basis and no longer just because of China. Earnings are expanding faster, too — as are margins. All positive stuff, he said.
Sharma also reminded us that many western countries are heavily debt dependent, with expensive stocks to boot. Emerging economies in aggregate are less stretched. Likewise, their stock markets trade at deep discounts to developed equities.
And yet and yet. The problem for me is that I remember reading such arguments back when I was wearing pinstripe suits (no belt, obviously) and Hermès ties. The buy-pitch never seems to change.
Emerging nations have young and fast-growing populations! They want to buy more things! Companies are cheap and less reliant on dollar funding! Governments are reforming! The west’s apogee has passed!
So why haven’t these obvious facts — as true as when you could fly from London to New York in 3.5 hours as they are today — translated into emerging stocks outperforming old-world bourses?
They still might. But I fear the likes of Sharma misread the runes. Take the statistic that from next year more than 80 per cent of emerging nations will have output per capita growth exceeding that of the US — up from about half in the period between 2020 and 2024.
Sounds good apart from the fact this level was also reached in the first 15 years of this millennium, when emerging markets only outperformed their developed cousins for less than half the period. That’s also a quarter century of no relative progress.
Meanwhile, median US household real income fell from $67,650 in 1999 to $63,350 in 2012 and real wages did nothing but move sideways. Over these years, however, the S&P 500 rose a fifth, a period which includes the dotcom bust and financial crisis.
Clearly there is more to equity prices than money in pockets — a point I have made often in this column. The mistake is equating volumes and value. Top line growth does not guarantee superior shareholder returns.
It doesn’t even guarantee rising profits. Think of what happens when demand surges for a product or service in Nigeria or Brazil (or anywhere for that matter). Capital flows in, competition increases, returns moderate.
And even that assumes all companies are trying to maximise their returns on capital. Often, bosses are more interested in empire building, market share, or paying themselves more. In many emerging markets, holders of equity are far down any priority list.
Another big mistake I think believers in emerging markets often make is also ubiquitous, but they make it with bells and sparkles on. And that is to forget that current prices discount the future many years and decades out.
My pet crocodile knows that power, influence and wealth are shifting south and eastward — as my colleague Janan Ganesh reiterated in his column on Tuesday. The stats are clear. Demography is destiny.
Thus, the emerging world’s golden century is already reflected in prices to a large extent. Nor are valuations any more attractive just because they are at least 35 per cent lower on a forward price-to-earnings basis, say, than the developed world’s. Such claims are simplistic and mislead absolute investors, those focused on making money, as opposed to institutional investors more concerned with relative returns against a benchmark.
It’s not just that the MSCI world index, for example, is crammed full of insanely expensive technology stocks (the US now makes up 72 per cent of this index and IT a quarter), making any claim to be cheaper somewhat, er, rich.
The MSCI emerging markets index is itself skewed by a 25 per cent weighting to China which, due to an imploding real estate sector among other reasons, has a forward price/earnings ratio of nine times — flattering comparisons still further.
In other words, it is perfectly possible that the valuation discount between emerging and developing market stocks will narrow, but owners of the former still incur losses. Not good: investors such as me are not playing a relative game.
If emerging equities are a bargain relative to history and their own fundamentals, however, that’s different. I will be exploring this next week.
The author is a former portfolio manager. Email: [email protected]; Twitter: @stuartkirk__
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