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U.S. vs. Emerging Markets Equities Insights

By Richard "Crit" Thomas, CFA, CAIA
International Equities
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Emerging Markets vs. U.S.

We believe equity investors should consider Emerging Market (EM) stock exposure due to the following more secular qualities:

  • Diversification: portfolios that included Emerging Market stocks have historically produced higher risk-adjusted returns (Bouslama and Ouda).
  • Relative Economic Growth: Emerging Markets are expected to account for 70% of global economic growth through 2025 with middle class spending growth being the main driver (McKinsey & Co).
  • Growing Middle Class: by 2025 Emerging Market consumption will represent approximately half of global consumption (McKinsey & Co).
  • Equity Market Expansion: Emerging Market equities represent only 12% of global equity market capitalization (Source: MSCI), yet their economies represent approximately 41% of global GDP (Source: International Monetary Fund).

But why now…?

Conclusion: Year-to-date, the MSCI EM index has nearly caught up with the S&P 500®. Many Asian countries were better able to contain the virus, enabling their economies to reopen more fully. Still, bottom up analyst earnings estimates suggest a more robust earnings recovery for the emerging market index in 2021 and 2022. That combined with lower relative valuations should allow for outperformance going forward.

Valuation

  • Emerging Markets have historically experienced significant price swings, creating large valuation peaks and valleys. Relative to the S&P 500®, Emerging Markets still look attractive, though most measures are distorted as a much larger drop in EM sales, earnings, and cash flow due to the more cyclical nature of EM are having a distortionary impact on these relative valuation measures. On a price-to-trailing-10-year-earnings basis, which smooths earnings cycles, the MSCI Emerging Market Index traded at 16x versus 31x for the S&P 500® (as of November 30, 2020).
  • The previous valuation lows occurred during the Asian Financial Crisis. Since that crisis, corrective action has taken place across many Emerging Market countries in both the public and private sectors. These actions included stronger regulations, fiscal policy, and capital controls. These measures helped prevent a major EM crisis from forming during the current downturn.

Relative Valuation Measures
Based on the MSCI Emerging Markets Index/S&P 500® Index as of November 2020

RANK 1-5*
Price/Cash Flow 4
EV/EBITDA 3
Price/Sales 2
Price/Trailing 10 Year EPS 1
Forward P/E 1
Summary Signal (Average) 2.2

 

Relative Price/Book and Relative Price/Sales

*Average of the five relative valuation measures.
Sources: Bloomberg, MSCI

Relative Earnings Prospects

  • Relative price performance and relative earnings growth have historically followed similar paths. S&P 500® Index earnings have been outpacing MSCI Emerging Markets Index earnings since 2008, helping explain S&P 500® Index outperformance.
  • We had anticipated a reversal in capital outflows as pandemic fears eased, and that has begun to happen. November saw one of the biggest inflows of capital into emerging markets on record. Capital inflows can help spur economic growth, creating a positive backdrop for earnings.

Relative EarningsSources: Bloomberg, Bloomberg Consensus Estimates, MSCI

Trend in EM Currency

  • The MSCI EM Index is quoted in U.S. Dollars (USD). As such currency shifts between the USD and EM currencies will impact returns directly. Secondarily, EM economies can be negatively influenced when the USD rises due to the higher interest burden on debt issued in USD. That said, a freely floating currency may act as a steam valve that over time self regulates the economic impact. The degree of economic impact differs by country and is mostly dependent upon how much debt is issued in USD and the importance of external trade with other countries.
  • Currency analysis is highly complex with short-term, medium-term, and long-term drivers on both sides of the ledger. In general, the medium-term and long-term drivers favor EM currencies over the USD. In the near-term, we believe EM currencies are likely to strengthen as/when the COVID crisis eases.

EM Stock and Currency Indexes

*Normalization adjusts or rescales the values of different time series to a notionally common scale to allow for comparability.
Source: MSCI

Emerging Markets Perspective

Emerging Markets equities are under represented in a global context given their relative size by other measures.

Emerging Markets as a Percent of the WorldSources: *International Monetary Fund (IMF) (2017), **MSCI (November 2020)

Glossary of Investment Terms and Index Definitions


This commentary is for informational purposes only and should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation to buy, sell or hold any security. There is no guarantee that the information is complete or timely. Past performance is no guarantee of future results. Investing in an index is not possible. Investing involves risk, including the possible loss of principal and fluctuation of value. Please visit touchstoneinvestments.com for performance information current to the most recent month-end.

Please consider the investment objectives, risks, charges and expenses of the fund carefully before investing. The prospectus and the summary prospectus contain this and other information about the Fund. To obtain a prospectus or a summary prospectus, contact your financial professional or download and/or request one on the resources section or call Touchstone at 800-638-8194. Please read the prospectus and/or summary prospectus carefully before investing.

Touchstone Funds are distributed by Touchstone Securities, Inc.*
*A registered broker-dealer and member FINRA/SIPC.

Not FDIC Insured | No Bank Guarantee | May Lose Value

crit thomas global market strategist

Richard "Crit" Thomas, CFA, CAIA

Global Market Strategist
Crit is responsible for examining and evaluating economic conditions, generating insights and providing a sharpened perspective on investment strategies for enriched portfolio construction.

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