It is somewhat ironic that the relative economic strength of the US in recent quarters has led to a dramatic outperformance of the US market, versus emerging markets. Typically, one would expect emerging markets to behave like a cyclical stock, outperforming during periods where the global growth outlook is improving.
While many emerging markets economies face the challenge of shifting their growth from export-driven to domestic consumption-driven, investors seem to have forgotten that exports remain a key driver of growth in these economies and a rebound from current lacklustre export demand has positive implications.
While growth in high profile emerging markets countries like China and Brazil has slowed down materially, emerging markets as a whole continue to grow at roughly twice the rate of the developed world and consumer demand has been surprisingly resilient amid slowing economic growth due to a continued rise in discretionary income.
Studies have shown that GDP growth tends to be impeded as government debt-to-GDP reaches 90%. The developed world in aggregate has debt-to-GDP that is roughly 90% and rising while emerging markets countries in aggregate have debt-to GDP of roughly 30%, which is falling. Emerging markets countries also possess significant foreign currency reserves (over two thirds of global foreign currency reserves), which could be used to stimulate growth.
In light of the superior economic fundamentals of emerging markets countries it is not surprising that emerging markets companies are generating higher levels of profitability (as measured by Return on Equity) than developed markets companies, as they have consistently since 2008. Yet even with this higher level of profitability emerging markets stocks trade at a significant valuation discount to developed markets stocks and this discount has only widened in the recent underperformance.
Emerging markets are also generating a higher yield than developed markets for the first time since 2008, and this dividend has much greater potential to grow. Emerging markets stocks look attractively valued both in absolute terms and relative to developed markets.
The Global Equity Income Fund’s bottom-up, valuation-driven strategy has led us to maintain a large and growing exposure to the emerging markets where valuations are truly compelling relative to the robust ROE’s and fast growing dividends available.
Our emerging markets allocation is quite diversified by country and sector but is fairly concentrated in BRIC (Brazil, Russia, India and China) countries in sharp contrast to a few years ago when the fund had almost zero exposure, as such countries were investor darlings and valuations were unappealing.
