I have touched on this point briefly in previous posts.  The relative outperformance of US Equities to other global equities markets (starting in the fall of 2010) has stalled in recent months.

I’ve been reluctant to mention the upswing in the relative outperformance of the emerging markets index (compared to the S&P 500) as quite simply in most cases, the emerging country equity markets and the companies that list on those exchanges (especially the companies that don’t dual list on one of the developed markets exchanges; dual listing on the London Exchange for example) require even more in-depth valuation research than the standard large North American market company.

For example, researching and valuating Russian companies is not a high level task.  In many cases, the outlook for the operations of the company is actually not too bad.  The valuation issue shows up once you go through the complex direct and indirect shareholder structure , dual class shares, the related company notes, easy domestic GAAP rules, aka non IFRS accounting, etc.  Signing on as a minority common shareholder just carries too much risk that simply must be adjusted for.  Once that additional risk adjustment is made, an unbiased equity analyst can’t value the common equity shares of that particular company the same way (discounting of the future cash flows) you do a widely held North American public company with the same operating outlook.

Call it country risk, call it cultural risk or what ever the appropriate risk term is.  The fact is there is additional relative risk and studying historical emerging country stock market action supports the fact this additional relative risk exists.   The impact of this additional relative risk may change (decline) in the future, but it certainly has not shown up in the last cycle stock market cycle; just look at China’s Shanghai Index the last three years.

I enjoy emerging markets investment research (in recent years I have done more emerging markets valuation than North American companies), but given the “fear factor” in the global capital markets, my top-down approach has led me to favor the North American markets (US dollar assets) and the companies that list on developed markets the last couple years.

Many emerging markets companies still dual list on developed markets.  When they de-list from the developed market exchange and cite the developed markets exchange and regulators reporting demands require too much effort and disclosure of too much financial and operating performance, on average, take it as not a good sign.  The North American exchange and securities regular reporting requirements are not that tough.  Generally, companies disclose what the investor community demands them to disclose for that particular industry (so the operations of companies/business units can be compared accurately).  It’s unbelievable how lax some emerging markets stock exchanges are in terms of reporting requirements.  Many companies have an easier time with the “spin room” in emerging markets (remember, most of the execs are trained in the US, the UK, etc.) than they do with the unruly North American minority shareholders.

Long US assets, avoid/sell most everything else, has been the right side of the long equity trade.  I know some individual emerging markets companies trade at good valuation levels and their time will come.

Courtesy of StockCharts.com: MSCI Emerging Markets Index vs S&P 500 Index:

MSCI Emerging Markets index (currency adjusted) vs S&P 500 index


I showed the price performance of the Hang Seng Index (the Hong Kong Index, at the top) even though the Hong Kong exchange is considered a developed market exchange.  Many of the largest Chinese companies are listed on the Hong  Kong exchange as Hong Kong is the “western money” gateway to Chinese companies, but it’s a different share class (H shares) than the shares available on the Shanghai exchange.   One of the many “factors” that makes emerging markets research and investing interesting, but the additional relative risk for minority shareholders needs to be accounted for.

Side note: In my experience, I’ve run across emerging markets company management and investor relations teams that are very good to deal with in terms of public disclosure and then discussing operational performance.  But that’s more the exception than the rule.

You can see from the main part of the graph that the currency adjusted performance of the emerging markets index stabilized around August/September 2012 and has been trending upward since October 2012.

The reason I show it now is that the relative performance has recently passed the 40 week average (around 0.706) and also the 12, 26 MACD technical indicator signal is now above zero.   I won’t get into technical analysis (maybe another day), but simply the  intermediate term technical trends are now positive for the relative performance of the MSCI emerging markets index to the US S&P 500 index.  Still, this does not make emerging markets a buy under my top-down approach.  Valuation always matters, eventually, and this is where the real hard research and proper valuation methods combined with a trading strategy comes in.

Still, I’m cautious on the global equity markets and especially the US equity market given the divergence of the US economic data from the performance of the US stock market as I’ve mentioned in several previous posts.  Any long positions require a significant downside portfolio hedge in this environment.


Until next time.



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