Re-Emerging Equities
Comment of the Day

April 19 2023

Commentary by Eoin Treacy

Re-Emerging Equities

Thanks to a subscriber for this report from AQR which may be of interest. Here is a section: 

However, lower risk in emerging markets isn’t just a China story. Fundamentals have also improved more broadly. Over the past 20 years, per capita GDP in emerging markets has roughly doubled as a share of developed markets (Exhibit 5, left side). Measures of external vulnerabilities have also improved from their periods of peak fragility in the 1980s and 1990s. Current account balances in emerging markets are now positive in aggregate, and measures of external debt sustainability (e.g., external debt as a percentage of exports) look much healthier (Exhibit 5, right side).

Bottom line: there are many reasons to believe that the relatively attractive valuations found in emerging markets represent a 5-10 year opportunity. In other words, the current expected premium is likely due to these markets being relatively underpriced, as opposed to representing compensation for assuming meaningfully greater portfolio risk.

Eoin Treacy's view

Here is a link to the full report. 

The technology sector is a bet on the future and as such it is a long duration asset. When rates are low and credit is abundant, the penalty for taking long-term bets declines and the allure of those assets is boosted. Cashflows, valuations and sustainability are only truly relevant when there is a discount rate to compare them to. Another way of thinking about it is expected returns tend to fall when bond yields are high. In order to surmount the hurdle rate of money market funds, fundamentals and valuations matter.

That implies something of a chicken and egg scenario for emerging markets. The higher rates go the less attractive high growth becomes. Speculation that we are approaching a peak in the interest rate cycle continues to support the Nasdaq-100. The potential outperformance of ex-US markets is based on the assumption the dollar will decline when the Fed peak is confirmed. The sticky nature of inflation suggests rates will not go back to zero and that will enhance the argument for focusing on valuations.

The similarities between the value/growth ratio and the EAFE/MSCI World ratio suggest there are strong similarities in the evolution of these trends where ex-US is analogous with value.

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