September 2018 Comments: Observations on Developed International & Emerging Markets

Victor Levinson Comments

While US stock prices have continued to rise, international and emerging stock markets have had a difficult year.  These markets are used by investors to provide global diversification for their portfolios. The results for the last few years, and 2018 year to date are as follows:

  2015 2016 & 2017 YTD 2018
Developed International (4.3%) +29.4% (1.6%)
Emerging Markets (15.3%) +46.8% (8.8%)
US (For Comparison) +0.4% +36.6% +10.6%

Some key characteristics of these market sectors are as follows:

Developed International (represented by Vanguard Developed Markets Index fund, VTMGX):

Regions: Europe 54%, Pacific 37%, North America 8%

Countries: Japan 22%, United Kingdom 14%, Canada 8%, Germany 8%, France 8%; Top 5 = 60%; Top 10 = 83%;

Companies: Nestle 1.3%, Samsung 0.9%, Novartis 0.9%, HSBC 0.9%, Roche 0.9%; Top 5 = 4.9%; Top 10 = 8.6%;

Sectors: Fincl. 19%, Industrial 16%, Cons. Discretionary 12%, Cons. Staples 10%, Healthcare 10%; Top 5 = 67%

Price/Earnings (PE) Ratio: 14; 3,900 stocks tracked


Emerging Markets (represented by Vanguard Emerging Markets Stock Index Fund, VEMAX)

Countries: China 35%, Taiwan 15%,  India 12%, South Africa 7%, Brazil 6%; Top 5 = 75%; Top 10 = 85;%

Companies: Tencent 5%, Alibaba 3.5%, Naspers 2%, Taiwan Semi. 2%, China Constr. 1.5%; Top 5 =13%

Sectors: Fincl. 22%, Technology 22%, Cons. Cyclical 12%, Basic Materials 8%, Energy 7%; Top 5 = 71%

Price/Earnings (PE) Ratio: 13; 4,500 stocks tracked


A number of recent articles discuss this situation.

The Economist Magazine (9/13/18) writes that “Emerging markets are suffering their worst slump since 2015. The MSCI Emerging Markets Index entered a bear market in early September after dropping 20 percent from its early 2018 peak.” The article mentions countries as diverse as Argentina, Turkey, India, and Indonesia, all having trouble supporting their currencies (note three of the four countries constitute less than 3% of the index). The article continues “while each country has its own challenges…the US Federal Reserve has played a key if unintentional role in triggering the stress…. With the American economy enjoying a strong upswing, the Fed has been raising interest rates (note, most recent rate increase on September 26), and also unwinding its bond buying policy….The Fed’s policy turn has left emerging nation borrowers scrambling to get more costly dollars to service their debt.” The remainder of the article presents various opinions on how much more serious these problems are likely to get going forward.

A second Economist article (9/22/18, page 65) discussed various countries, including China. The article begins by citing the falling currencies in India and Indonesia, and then states that “even where Asia’s currencies have remained steady, its stock markets have faltered, citing a 20% decline in Hong Kong’s index and a struggling stock market in Mainland China….The trade war with the US has soured the mood in China and Hong Kong….India and Indonesia report respectable economic growth…  and are largely insulated from the trade war thanks to their domestic demand, but are exposed to two other dangers, higher oil prices and America’s remorseless money tightening.”

The NY Times reported on this situation as follows (9/11/18, page B1): “Cratering currencies, rising inflation, jumpy investors: A financial panic is again gripping some of the world’s developing economies. The sharp selloff of emerging market currencies, stocks and bonds seems to stand in stark contrast to the US, where a nearly decade long bull market continues amid buoyant economic conditions. Higher interest rates in the US, and a stronger dollar, rebalance the risks and rewards for investors the world over and act as a kind of financial magnet, pulling them out of riskier investments. While we’ve seen this before….investors had to contend with spillover of trouble from one country to others, dragging down economic growth or causing market stress. So far in 2018 this kind of contagion has been limited. Economies as varied as Argentina, Russia, South Africa and Turkey are facing the maelstrom, but each has its own reasons for falling out of favor, and the turmoil has yet to raise anxiety about the world’s biggest economies and markets.”  The article then discussed the situation in each of the four countries and concludes that “Perhaps most important is a country’s credibility with financial markets. If investors believe a country will continue to pay its bondholders in a currency that retains its value, they will most likely put up with even the ugliest looking levels of debt. If that trust starts to fray, look out below.”

Another NY Times article (9/13/18, page B7) discussed the Developed Markets in Europe. Citing the negative impact of US tariffs, the article states that “the European Central Bank (ECB) has lowered its projections for economic growth across the 19 nation euro area, and warned that any potential escalation of the dispute could create further headaches.” The article also notes trade risks associated with emerging market problems, particularly in Turkey, along with issues related to striking a deal with Britain regarding “Brexit.”  The conclusion of the article however states that the ECB will continue with its plans to cut back on the stimulus programs that were put in place after 2008, in much the same way that the US has cut back these programs, albeit the US economy is much stronger than the EU at this time. The EU outlook currently appears to be much more mixed than that of Emerging Markets, which are wrestling with debt, interest rate, and growth issues.

Despite the current underperformance of Developed International and Emerging Market stocks, we at Park Piedmont continue to advocate some exposure to these sectors as part of a broadly diversified portfolio, particularly since their PE ratios are in the mid-teens, compared to much higher US stock PE ratios, which have climbed to the mid-20s. When PE ratios show this much divergence, it can be argued that the lower PE sector represents a comparative value when compared to the higher PE stocks. As always, only time will tell if this proves correct.