Emerging Market Equities are Lagging Developed Market Equities

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The performance of most emerging market equities in the past few years has been average to poor. Developed markets have especially performed well in the recent past handily beating their emerging market peers. The BRICs used to the hot destination for many years. However collectively they have disappointed investors with the exception of India.

Compared to the double digit returns of most European markets and the decent performance of the U.S. markets so this year, emerging markets are still lagging. The following chart shows the 5-year returns of the MSCI Emerging Markets Index and the EAFE Index:

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MSCI EM vs EMEA Index-5 Years

Source: MSCI

The chart shows that emerging markets have been under-performing developed markets since 2013. The gap between the performance of developed stocks and emerging stocks continue to widen.

The iShares MSCI Emerging Markets ETF (EEM) was down about 3% in both 2013 and 2014.

Despite the poor performance of emerging stocks, it is not a good idea to completely write them off. There are still opportunities to be found in those markets although one has to very selective. Certain sectors such as real estate, technology, consumer discretionary can be avoided. And investors can consider stocks in the consumer staples, utilities, banking and retail sectors. This is as consumers in developing countries move from lower-income to middle-income levels they spend their disposable income buying products and services from companies operating in these sectors.

Five emerging market companies that investors can consider are listed below:

1.Company:Vina Concha y Toro SA (VCO)
Sector:Beverages
Country: Chile

2.Company: ICICI Bank Ltd(IBN)
Sector: Banking
Country: India

3.Company: Fomento Economico Mexicano SAB de CV (FMX)
Sector: Beverages (Nonalcoholic)
Country: Mexico

4.Company: Turkcell Iletisim Hizmetleri AS (TKC)
Sector: Mobile Telecom
Country: Turkey

5.Company: Companhia Brasileira de Distribuicao (CBD)
Sector: Food & Staples Retailing
Country: Brazil

Disclosure: No Positions

Historical U.S. 10 Year Treasury Yield Chart

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The current yield on the U.S. 10 year Treasury note is 1.96%. In the past five years, the yield has dropped from about 4% to about 2% recently. In the past, U.S. Treasuries have yielded excellent cumulative returns during certain periods.

The following chart shows the historical yield on the U.S. 10-year Treasury from 1954 thru 2014:

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Historical U.S. Treasury Yield Chart

Source: Global Market Insights – Inefficiencies and opportunities in today’s fixed-income markets, Deutsche Asset & Wealth Management

The yield rate peaked in the 1980s when it reached over 14%. Since then it has followed a long-term downward trend.

With the yield treasuries so low its no wonder investors are putting more money into U.S. equities. There are plenty of equity opportunities which have dividend yields of well over 2%. Of course, equities are not the same U.S. Treasuries but still there is a reason investors are attracted to high-quality dividend stocks these days.

Why Foreign Stocks Are Still A Buy

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International equities are leading U.S. stocks this year. For example, developed European markets are well ahead of American stocks at least so far this year. The year-to-date returns of some of the major equity markets are listed below:

S&P 500 Index: 2.39%
Canada’s S & P/TSX Composite: 2.1%
UK’s FTSE 100: 7.0%
France’s CAC 40: 19.1%
Germany’s DAX Index: 22.8%
Spain’s IBEX35 Index: 11.1%
China’s Shanghai Composite: 11.8%
India’s Bombay Sensex: 2.8%
Brzail’s Sao Paulo Bovespa: 3.9%

Data Source: WSJ

With major European markets such as Germany trouncing the U.S. this year, some investors may be wondering if foreign stocks are still attractive at current levels. Fundamentals show that foreign stocks have still room to run. Developed stocks especially are attractive even after the current run up. I came across an interesting article by David L. Ruff, CFA of Forward Management in which he lays out the arguments in favor of international stocks. From the article:

International equities are attractive now
Historical trends unfortunately don’t reveal much about exactly when international equities may once again outperform, but a variety of metrics, including yields, valuations and earnings, reveal international stocks to be attractive in the current climate regardless of their relation to U.S. equities. As shown in the chart below, dividend yields are higher abroad. Valuations also favor non-U.S. equities, with foreign markets trading at 45% to 50% discounts on a price-book basis. While profitability favors the U.S., non-U.S. returns on equity are also attractive. Earnings growth for Europe and Japan has overtaken the U.S. due to weakening in their currencies and lower oil prices will help foreign markets with greater hydrocarbon/commodity import exposure. These metrics highlight that it is unnecessary and even unfavorable to wait for outperformance as great opportunities exist in international equity markets right now.

Key Metrics: U.S. vs. Non-U.S.

Country Dividend Yield 3-Year Dividend Growth Rate Price- Book Price-Earnings Enterprise Value/ EBITDA Latest Earnings Growth5 Return on Equity
U.S.1 2.02% 18.8% 2.7x 17.6x 11.1x 7.4% 23.1%
Non-U.S.2 3.19% 16.5% 1.5x 15.0x 8.4x 4.9% 17.3%
Non-U.S. Developed3 3.33% 15.6% 1.5x 16.2x 8.7x 17.2% 16.8%
Emerging Markets4 2.67% 20.6% 1.4x 12.1x 7.5x -7.2% 18.3%
Sources: Morningstar, HFR and Forward, as of 01/15/14
Past performance does not guarantee future results.1 Based on iShares S&P 500 Index data
2 Based on iShares MSCI ACWI World ex-USA Index data
3 Based on iShares MSCI EAFE Index data
4 Based on iShares MSCI Emerging Markets Index data
5 Latest earnings seasons quarterly earnings year-over-year growth, 10/15/14-01/15/15
Source: Don’t Stop Believing: The Case for International Equities, Mar 12, 2015, Forward Management LLC

Investors willing to wait for five years or more can consider adding developed equities at current levels though additions in smaller chunks is better than a single investment.

Five stocks from developed countries in the MSCI EAFE Index are listed below for further research and potential investment:

1.Company: Singapore Telecom (SGAPY)
Current Dividend Yield: 4.20%
Sector: Telecom
Country: Singapore

2.Company: Westpac Banking Corp (WBK)
Current Dividend Yield: 5.12%
Sector:Banking
Country: Australia

3.Company: Enbridge Inc. (ENB)
Current Dividend Yield: 3.04%
Sector: Oil & Gas
Country: Canada

4.Company: Cathay Pacific Airways Ltd (CPCAY)
Current Dividend Yield: 1.48%
Sector: Airline
Country: Hong Kong

5.Company: Rogers Communications Inc (RCI)
Current Dividend Yield: 4.34%
Sector: Telecom
Country: Canada

Note: Dividend yields noted above are as of Mar 20, 2015. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: No Positions

Three Reasons Why Investors Should Hold Emerging Market Stocks

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Emerging markets have been laggards in the past few years compared to their  developed world peers. Among the developed stocks, U.S. stocks especially had a superb run last year compared to European stocks. However this year, the tables seem to have turned with European stocks outperforming American stocks so far.

With the poor performance of emerging stocks recently some investors may be tempted to dump them altogether now and move their assets to developed stocks. This strategy is not a wise for many reasons. Before we get to those, lets take a quick look at the annual return of emerging market stocks as represented by the MSCI Emerging Markets Index:

Year2014201320122011201020092008
Return-2.19%-2.60%18.22%-18.42%18.88%78.51%-53.33%

Source: MSCI

Since the Global Financial Crisis, emerging stocks returned double digit growth in 2009, 2010 and 2012. But more recently in 2013 and 2014, they performed poorly with negative returns of 2.60% and 2.19% respectively.

Despite losing money in the past two years, emerging stocks still have a place in equity portfolios. The following are a few reasons to hold emerging stocks now:

1. Some emerging markets have strong and growing economies and their equity markets would soar accordingly. For example, last year India was one of the top performing markets in the world while Brazil was not. So one way to profit from growing emerging economies is have to some investments in those countries.

2. Emerging companies have decent dividend yields. More importantly, many are raising their payouts to shareholders as they try to attract domestic and international investors. Even in South Korea, where companies are not known for shareholder-friendly dividend policies recent tax policy changes may make them share more earnings with investors. In terms of emerging dividend yields, the MSCI Emerging Markets Index has a yield of 2.60% as of Feb, 2015. This is better than say the average yield on the S&P 500 which is about 2%. But this does not mean emerging stocks are better than stocks. It simply means that certain developing countries such as those included the MSCI index have firms that pay good dividends. The key is to do research and identify them.

3. One important reason to hold emerging stocks is the concept of diversification means owning laggards. From an article I wrote in December last year quoting Seth J. Masters,Chief Investment Officer of Bernstein Global Wealth Management:

After leading globally in 2013, in 2014 through November the US stock market beat developed international stock markets by 15.5 percentage points in US dollar terms; it beat emerging markets by 11.5 percentage points, as shown in the first Display, below. This outperformance by US stocks has some investors ready to throw in the towel on global investing.

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Why Go Global

We think selling an asset after a stretch of lagging performance is a bad decision. Often, the lagging asset may be more attractive looking ahead. And that’s what we’re seeing in developed international stocks markets, where valuations are more attractive than in the US stock market.

Since 1990, non-US stock markets have outperformed the US market more than half the time. Since no one can be certain just when this will occur, we think it’s wise to own stocks in all regions.

Investors not already having exposure to emerging market equities can consider adding the following stocks in a phased manner:

1.Company:Taiwan Semiconductor Manufacturing Co Ltd (TSM)
Current Dividend Yield: 2.02%
Sector: Semiconductors & Semiconductor Equipment
Country:Taiwan

2.Company:Empresa Nacional de Electricidad SA (EOC)
Current Dividend Yield: 2.53%
Sector:Electric Utilities
Country:Chile

3.Company: HDFC Bank Ltd (HDB)
Current Dividend Yield: 0.56%
Sector: Banking
Country: India

4.Company:Banco Santander- Chile (BSAC)
Current Dividend Yield: 4.65%
Sector: Banking
Country: Chile

5.Company:Bancolombia (CIB)
Current Dividend Yield: 3.76%
Sector: Banking
Country: Colombia

6.Company: Standard Bank Group Limited (SGBLY)
Current Dividend Yield: 3.84%
Sector: Banking
Country: South Africa

7.Company: Embraer SA (ERJ)
Current Dividend Yield: 1.65%
Sector: Aerospace & Defense
Country: Brazil

8.Company: PetroChina Co Ltd (PTR)
Current Dividend Yield: 4.84%
Sector: Oil
Country: China

9.Company: Malayan Banking Berhad (MLYBY)
Current Dividend Yield: 6.64%
Sector: Banking
Country:Malaysia

10.Company:Philippine Long Distance Telephone Co (PHI)
Current Dividend Yield: 5.59%
Sector: Telecom
Country: Philippines

Note: Dividend yields noted above are as of Feb 20, 2015. Data is known to be accurate from sources used.Please use your own due diligence before making any investment decisions.

Disclosure: Long BSAC

You may also want to check out:

Emerging Market Equities in 2015 – the ugly, the bad and the good, March 15, 2015, Fidelity UK