EMERGING MARKETS – DISCOUNT TO US STOCKS
In 2009, we had no money invested in emerging markets. Today, we are overweight international stocks – especially emerging markets. In 2017, emerging markets generated returns in excess of 30%. Despite this performance, emerging markets have significantly underperformed since their glory years that ended in 2009. Much of the financial news in 2009 was that we were in a new world order and the BRICS (Brazil, Russia, India, China and South Africa) would be better investments than the US. Fortunately, we did not buy into that mantra.
We continue to be overweight emerging markets while having our lowest exposure to large US companies. Below is a chart comparing the valuations of the US stock market to emerging markets as of December 31, 2017:
CAPE P/B P/S Dividend Yield
United States 30.5x 3.3x 2.2x 1.8%
Emerging Markets 17.3x 1.8x 1.4x 2.7%
The first three indicators are measures of valuation. The term CAPE stands for Cyclically Adjusted Price/Earnings ratio. P/B is price divided by book value. P/S is the price divided by sales. By all three measures, the US is selling at a much higher price than emerging markets. The last column shows emerging market equities have a current yield of 2.7% compared to 1.8% for US equities. To say this is unusual is an understatement – emerging market equities historically have had a lower yield than US equities.
Over the past few days we have seen some volatility in the market to the downside. Even though we are overweight emerging markets, we continue to be underweight stocks overall and overweight uncorrelated assets. In the past, emerging markets have suffered more than US stocks during turbulent times. At those times, emerging markets were selling at a premium to US stocks. Today, they are selling at a significant discount to US stocks. We believe that over the next several years, the disparity between emerging markets and US stocks will go away as emerging market stocks outperform US stocks.