A recent Financial Times article debates the long-standing assertion by GMO that emerging market shares are a good deal, citing the firm’s comment that “EM equities are as appealing as ever, given they are as cheap as they have been since the heady days of the tech bubble.”
The article rebuts, “Yet take a look beneath the surface of index-level data and you could argue that emerging market stocks are hardly the baring that they seem to be.” Breaking the EM index (as measured by MSCI) into sectors reflects that EM “often trades on a par with, and in some cases even at a premium to, its US counterparts.”
Sector Analysis
The article notes, “It’s clear from these data that the bulk of the EM discount resides in a few sectors which are generally associated with domestic revenue streams,” including banks utilities, energy and materials.
Currency Markets
The article also argues that EM stocks can only outperform developed markets if their respective currencies appreciate. “For a US investor,” it explains, “this is a critical point; over the decades since MSCI’s EM index began in June of 1988, excess returns for EM relative to the US have coincided with significant dollar weakness:”
The article asserts, “it seems a rather tall order to have one’s equity bets so reliant on something as fickle as the currency market.”
Tech Bubble Comparison
GMO contends that EM equities are positions to hold up better than expensive US stocks as they did in the wake of the tech bubble:
But the article argues, “this particular period of index returns had more to do with the excessive tech weighting in the S&P 500 index as the bubble popped, as well as a decline in the dollar, than it had to do with EM being cheap.”
Conclusion
“It is difficult to share GMO’s enthusiasm for emerging markets. In addition to not being as cheap as they appear, the majority of EM markets are overly concentrated in financial stocks, and they are subject to large drawdowns due to political and fiscal instability, among other things.” The article adds that the GMO stance requires “too many external factors to work to make it worth the risk.”
