Market Musings 050524: The EMpire Strikes Back
I want to talk today about emerging markets, which have been out of favour for quite some time now. They've underperformed developed markets by a wide margin for a long time, but may finally be becoming more interesting. We can first of all divide the investable public stock universe for the most part into four segments, three segments being developed markets:
- US at 63%,
- Europe at over 17%, including the Eurozone UK, Switzerland and Sweden,
- Japan at over 5%
and then a fourth segment, which are emerging markets representing about 10%, if we look at the MSCI All-Country World Index, which is the industry standard.
Since 2020, performance has generally been strong for most stock markets, led by the US at plus 70% in Euro terms since the beginning of 2020, the Euro STOXX 50 +48%, the UK +25%, Japan +28%, or +71%, if you'd hedged your exposure to the yen.
But Emerging Markets at only +8% since 2020 have really done extremely little and been a dramatic underperformer relative to developed markets.
However, the story is a little bit different looking year to date. Here we have US +12% in euro terms, Eurozone +10%, Japan +10%, Emerging Markets +8%, so actually keeping up more or less with developed markets and actually they've outpaced developed markets since February. So much more even this year in terms of performance.
If we look at valuation, emerging markets are clearly much cheaper as a whole than for instance the US in terms of PE valuation, 12 times only for the emerging markets, whereas you pay 20 times much more expensive valuation for the US and markets such as Eurozone, UK and Japan somewhere between the two.
According to long term expected return models, a lower PE valuation today should yield higher future returns for investors over the next 5 to 10 years. If we look at BlackRock's capital long term expectations model to see what long term returns they forecast, they forecast over the next 10 years +3.2% on average per year for US large caps in Euro terms versus +6.8%, more than double, for emerging market equities over the next 10 years. So clearly the lower valuation today should result in higher returns in the future. And that is the that is the argument of this model…
