Looking back at almost any stock index over the past few years, even over the past decade, it’s clear that, on a relative basis, U.S. equities were the only game in town. To wit, over the past 10 years, the U.S. market has outperformed the rest of the world by a stunning 130%, or 7% on an annualized basis.1 With the exception of a few periods, investing in non-US equities has been a costly allocation decision.2
This year the divergence between the U.S. and Emerging Markets has been particularly acute given trade disputes initiated by the current U.S. Administration. Coupled with a rising dollar, investors have been heading to the exits, leaving the markets down by 10% year-to-date. It has been particularly painful for a few countries (e.g. Turkey, Argentina) that have high external debt balances relative to the size of their economy. In stark contrast, U.S. markets have appreciated 8%+ as investors focused on strong earnings growth domestically. As a result, the gap in relative performance and valuation between the U.S. and emerging markets is the widest it has been in over 20 years.
However, looking to 2019, a more favorable emerging markets earnings picture is beginning to come into focus. As the U.S. is well into the longest economic recovery on record, wage inflation is starting to accelerate, prompting the Fed to continue its fiscal tightening. Higher interest rates should begin to weigh on U.S. valuations while the rest of the world and emerging markets’ central banks remain broadly accommodative. China’s leading indicators point to a resurgence in China’s growth following July stimulus measures. Hence the outlook for emerging markets fundamentals may be improving.
Emerging markets equity valuations have become very attractive, and have in some areas dislocated from underlying fundamentals. In absolute terms, forward PE ratios show emerging markets equities to be trading below their long-term medians and the lowest level in over three years. Furthermore, Latin American markets are trading below their -1 standard deviation, the lowest levels in more than five years. When valuations reach these discounts, and with sentiment this gloomy, history typically shows the pendulum swinging back.
While the Tiedemann portfolio has been correctly underweighted in non-U.S. developed equities, it has maintained its slight overweight in emerging markets equities. Tiedemann’s strategy is to work with managers to build a portfolio of high-quality companies in a given region. These companies typically trade at a premium due to their high-quality nature and exposure to faster growing markets. Today, this is not the case in Latin America.
We anticipate a more favorable earnings growth rate in 2019 for emerging markets. While the U.S. equity market is expected to grow about 10%, emerging and Latin American markets show higher expected growth rates. On the other hand, risks to the U.S. earnings picture such as higher oil and commodity input prices should be a boon for most emerging economies. Additional upside to emerging markets earnings estimates could come from any combination of a rebound in local currencies (which have been a primary source of negative return in 2018), a pick-up in demand from China, or a U.S.-China trade dispute resolution.
Though the picture remains opaque given the uncertainty of trade, any one of the above outcomes would help pull sentiment up from its multi-year lows, allowing investors to once again focus on fundamentals. With such attractive valuations, history shows that leaning in when times are darkest can reward investors willing to remain patient.
Paul Buongiorno is a Managing Director of Tiedemann Advisors LLC. Tiedemann Advisors is an investment advisor. The information presented herein is intended as an illustration of the services offered by Tiedemann and such services may not be suitable for all individuals. This information does not constitute, and should not be construed as, the provision of tax, accounting or legal advice or investment recommendations. This information is intended to serve as the basis of a discussion with a Tiedemann professional. We urge you to consult with your tax or legal advisors prior to entering into any planning or trust arrangements.
1 This is the case when the Morgan Stanley Capital Index excluding the U.S. is compared with the MSCI U.S. index for time period June 2008 through June 2018. [Source: Bloomberg]. Performance figures are unaudited. This material is as of the date indicated, is not complete, and is subject to change. Additional information is available upon request. No representation is made with respect to the accuracy, completeness or timeliness of information and Tiedemann assumes no obligation to update or revise such information. Certain information has been provided by and/or is based on third-party sources and, although believed to be reliable, has not been independently verified and Tiedemann is not responsible for third-party errors.
2 Tiedemann does not guarantee the future performance of your Account, promise any specific level of performance or promise that its investment decisions, strategies or overall management of your Account will be successful. The investment decisions Tiedemann will make on your behalf are subject to various market, currency, economic, political and business risks, and will not necessarily be profitable.