Internationally-minded investors thought global diversification would benefit them. So, in recent years, investors placed nearly a trillion dollars of long-term assets into global equity mutual funds.
Globally diversified investors put their largest concentration of assets into broad global mutual funds that invest across all non-U.S. regions (at around $500B).
Following this were Asia-focused funds (at around $300B).
Source: EPFR Global
However, instead of outperforming concentrated positions tracking U.S. or German indexes, most international indexes and mutual funds keep underperforming in 2013.
Numerous regional and country share indexes have extended a streak of underperformance that stretches back to mid-2010.
Consider the MSCI Emerging Markets Index, tracked by the iShares MSCI Emerging Markets Index Fund (EEM). It fell -3% YTD versus a +17% rise for the S&P 500 (SPY). That benchmark has hit a string of record closes in 2013. The German DAX index (DAX) is up nearly +12% YTD. It set an all-time high in May.
Four Fact Sets on Global Stock Underperformance
Three years of underperformance leaves emerging market stocks trading at the biggest discount to developed-market stocks in five years. Ponder these four fact sets:
(a) Many major emerging-market companies are more profitable and less burdened with debt than developed-world counterparts. Think Samsung and Hyundai.
(b) Consider the weak technical backdrop and future fate of stagnant shares in Spanish banks BBVA (BBVA) offering a 4.6% dividend and Santander (SAN) offering an 8.6% dividend yield with broad exposure to Latin America.
(c) Take a look at regional and country MSCI 12-month Price-to-Earnings equity valuations shown below.
This Equity Valuation table shows a current valuation opportunity of nearly 30% in Europe over its 10-year P/E average, 10% in Asia, and close to 10% in broad emerging markets indexes. Interestingly, going in the other direction, Latin American regional indexes look overbid by about 20%.
At a large country ‘BRIC’ level, Russian shares may offer a nearly 50% premium over their 10-year valuation averages; Chinese shares a 25% premium; Indian shares a 12% premium. Going in the other direction, Brazilian shares may be overvalued by 20%.
Source: Morgan Stanley Capital International.
(d) Investors hear about a 2% dividend yield on the S&P 500 index. However, equity indexes tied to the “Rest of the World” offer sweeter Dividend Yields to investors.
Current dividend yields compared to 10-year average yields on the same index offer another take on under and over-valuation in global indexes.
Consult the MSCI international index dividend yield table below. The biggest dividend opportunities are listed at the top of each rank.
Source: Morgan Stanley Capital International.
What Holds Global Shares Back?
When it comes to global markets, there are enduring reasons to doubt these equities can shake underperformance.
- Analysts deeply in the know urge investors to remain overweight developed market equities.
- Analysts remain particularly cautious on emerging markets — due mainly to worries about China’s growth prospects.
Are significant stock bargains to be had as a result of emerging market index underperformance? Could overdue portfolio rebalancing toward emerging world indexes, specifically country indexes like Russia and China, be on its way?
Here are the three big enduring reasons to stay away:
1. A Slowing China
Emerging-market investors came into 2013 partly buoyed by expectations China’s GDP growth was intact. But signs the Chinese economy is slowing has helped push down commodity prices.
China is just one part of the broader slump in commodity prices. The drop in oil, precious and non-precious metals, and agricultural commodity prices is making life rough for lots of emerging-markets investors. The MSCI emerging markets index is heavily weighted toward Energy and Materials sectors, which has hurt its performance.
It’s spelled trouble for funds heavily weighted toward country indexes like Brazil or Russia too. These countries have commodity-dependent economies that offer major Materials and Energy stocks to international investors. Funds that had been more focused on the so-called BRICs — Brazil, Russia, India and China — had a leg up when commodities were booming. They have been left behind compared with funds exposed to booming emerging stock markets without major Energy and Materials companies, like as Indonesia and Turkey.
2. Aggressive Easing in Japan
Japan’s leaders get some blame for ongoing stagnation in emerging markets’ shares.
Aggressive monetary and fiscal stimulus has sent the Japanese yen plunging. Japan’s benchmark Nikkei stock index has rallied nearly +70% since November — even after a recent big correction.
The slumping yen — down more than -15% versus the U.S. dollar YTD — aids Japanese exporters. But it works against competing Asian companies outside Japan. In response, South Korea’s KOSPI Composite Index is down -1.2%.
For example, a weak yen hurts South Korean automakers Hyundai and Kia, who compete directly against Japanese companies Honda (HMC) and Toyota (TM). The weak yen is not an obstacle for Asian, European, and U.S. firms that are part of Japan’s automotive supply chain.
3. A Strident Germany
Germany’s leaders don’t look much better.
In Europe, the irony of the situation is there may be a “beggar-thy-neighbor” condition playing out inside Europe. An entrenched fiscal/balanced budget situation and an overvalued real effective euro currency in terms of internal European trade buttress the German economy.
This may be part of what is holding back the rest of Europe.
What About Global Markets Value Catalysts?
A few savvy pundits contend it is time for investors to scale up global market exposure. Why?
• There are signs Europe’s GDP slide is at least slowing.
• The U.S. economy may be building up GDP growth. Global spillovers could be significant.
These two catalysts could lead to institutional portfolio rebalancing towards global markets.
- Ponder whether a domestic move out of expensive, defensive sectors into cyclical stocks could be replicated or tracked inside emerging markets.
- Another stealthy conclusion? Watch specific global Info Tech and Health Care shares and find a nice entry point.
Global Info Tech companies offer value priced cyclical stocks with less downside risk than global/macro driven sectors like Energy and Materials. A good example would be NetEase (NTES), a mainland Chinese Internet Technology company.
Certain global shares can be cash-rich. Look at Australian fixed and wireless telecommunications company Telstra Corp. (TLSYY). Australia’s principal telco offers a 6% dividend yield.
Global Health Care shares can also deliver on strong and stable earnings growth expectations. Look at Italian Luxottica Group Spa (LUX). The company is a leader in premium, luxury, and sports eyewear with approximately 7,000 optical and sun retail stores in North America, Asia-Pacific, China, South Africa, Latin America and Europe. Proprietary brands include Ray-Ban, the world's most famous sun eyewear brand, Oakley, Vogue Eyewear, Persol, Oliver Peoples, Alain Mikli, Arnette and REVO.
Inside the Zacks Rank world, global Info Tech and Health Care consumer stocks deliver low double-digit earnings growth annually.
And more earnings surprises!
The stocks I mentioned in this last section are Zacks Rank #1 now.
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