US markets, after dividends, have almost completely restored the book value to investors after the financial crash on 2008. Several key US indices are flirting with all time highs despite anemic rates of growth (0.4% in 4Q2012 by the last official estimate) largely due to ongoing contraction in government spending. By contrast, the developed markets outside the US have suffered through recent shocks and austerity (e.g. The Italian election & Cyprus Bailout) with less market resilience and even lower expectations of growth.
By comparison, The first quarter has been a little rough for emerging markets. Developed markets were up 5% in 1Q 2013 and the US is up about 11%, whereas Emerging Markets actually went negative (-1.62% to be specific) during the quarter. How can Emerging Markets underperform so drastically given the large consensus that growth rates in Emerging Markets will solidly exceed the GDP rates in both the United States and the Developed Markets?
There are multiple features going on here. First, there is the currency effect. Most investments in international equity and fixed income are un-hedged to a currency. In other words, if you buy stock in a uniquely stable Indian company and the price does not move whatsoever in local currency (the rupee), the market price to US investors can still change for US investors as the exchange rate between Indian rupees and US dollars oscillates. Despite the challenges to the US economy, the long term resilience and maturity of the US economy has made the dollar a relative safe haven.
Currency effect only tells half of the story. After all, developed markets have outperformed emerging markets over the trailing 1 and 3 year numbers (although not including the full market crash on the 5 year horizon). It is useful to remind investors that markets do not trade a stock based upon the intrinsic value of a company today, but rather upon the market’s aggregated best-guesstimate of a company’s value over time. After several years of explosive growth, the stratospheric expectations for emerging market growth have been tempered somewhat since the worldwide slowdown. More specifically, the worldwide slowdown challenged the “decoupling” theory which suggested that emerging markets would continue to experience growth, unaffected by their troubles of their neighbors.
Noting that the worldwide slowdown does not affect all developing countries equally, economists and market analysts have sought to delineate the sources of growth and the relative positioning of emerging market economies in the context of their peers. The largest emerging markets – the “BRIC” (Brazil, Russia, India and China) have suggested paths of economic and market development to be followed by “Next Eleven” or “CIVETS” countries (e.g. – Mexico, South Korea, Turkey, Indonesia, etc..) Several of these countries, although immature compared to the North America and Europe, are considered newly industrialized lower on the scale of economic development. In contrast, economists have noted countries even further down on the development scale – so called “frontier” markets that have currently undeveloped systems, but with potential for high and sustained growth.
Practically speaking, it is perfectly legitimate to distinguish the living standards, political stability, economic development, educational levels of the wide swath of emerging markets. For example, South Korea is a sophisticated technological powerhouse (home to Samsung, Hyundai Kia) that develops and protects intellectual products and heavy industry goods. Although they are both east Asia emerging market countries, South Korea might expect less explosive market returns than its neighbor Vietnam which, despite rapid advances, still depends more upon exports of agricultural commodities and inexpensive labor.