INSIGHTS

On April 09, 2015

Don’t Neglect One of the Four E’s

For convenience and memory, a simple way to classify where we see the most value in 2015 can be broken down to four E’s: Europe, Energy, Essentials (Basic materials) and Emerging Markets. 

One area that seems to have a lingering dark cloud around it is emerging markets, though the returns to date show a completely different weather pattern.  Our favored emerging markets were Brazil, Russia, India, China and Korea, as well as adding Mexico to the list.  As shown below, although performance has been strong year to date, it is still an undervalued investment on a broad based measure and we continue to expect more growth. 

Source: JP Morgan and Bloomberg.  Past performance does not guarantee future results.

Mainstream investors appear to be hesitant to allocate funds to emerging markets given concerns about the Federal Reserve raising rates as well as increased capital outflows.  As a whole, emerging markets are trading at 11.9x forward earnings which is just slightly below our basket average.  We expect headline risks to persist for the foreseeable future, however as the first four months of performance have shown, perhaps the consensus negative perceptions are already priced in. 

Another large concern that has riddled the emerging markets for several years is food inflation, as there are few buffers against quick price increases that you see in developed markets.  Since the peak in 2011, agriculture prices as a whole have declined fairly substantially, which complements the decrease in energy prices.  The conversation regarding food and energy on emerging markets is somewhat circuitous, meaning offset by other forces in quick action. 

There has been an interesting recent pattern in dealing with currency risk and emerging market equity performance.  Consider the Barclays Emerging Market Currency Risk Index and one may notice more pronounced peaks since 2008 than was seen prior.  To calibrate this analysis to fit with the current situation, consider the returns in the MSCI Emerging Market Index for the nine months following each peak in this index.  This is used as an attempt to put year-end potential for 2015 since the index peaked on 12/17/14 recently. 

Barclays Emerging Market Currency Risk Index (Barclays EM FX risk index)

Source: Barclays, Bloomberg

The 9-month returns for the previous 3 peak points (green circles) was 93.8%, 17.25% and 11.25%.  Even as we had pronounced periods of currency volatility in the past, the markets continued to have ample more room for them to grow. 

CRN: 2015-0402-4705 R

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