Assessing emerging market noise in a post-truth world


 By Craig Mercer*

Post-truth /pəʊs(t)ˈtruːθ/ adjective relating to or denoting circumstances in which objective facts are less influential in shaping public opinion than appeals to emotion and personal belief.

Oxford Dictionary

In late 2016, Oxford Dictionaries announced the word post-truth was its ‘word of the year’.  The organisation determining that, while the word had been used over the past decade, it moved from peripheral usage to an integral part of the lexicon of political commentators following Brexit and the presidential election in the United States. The rise and the power of a post-truth world not only has wide-reaching implications in politics but also in the world of finance.

The focus of market practitioners on short-term earnings, the pace of the media news cycle and ever dwindling patience has a negative impact on an investor’s ability to generate sound returns. This is increasingly problematic when objective facts are less influential in shaping opinion. The fact that emotional appeal has become more important in decision making in the short-term provides an opportunity to win over the long-term when you focus on the objective facts.  To illustrate this, we like to use the analogy of a tree in a forest. Most of the market spends its time trawling news sources and data feeds to understand if a new leaf on an offshoot branch is going to sprout. When that branch breaks off in a storm the practitioners go into a frenzy, while forgetting to look to see if the trees roots remain anchored and healthy, and beyond that, if the forest is still standing. Or, as Benjamin Graham considered, “the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.” As he implied, you should assess intelligently whether to follow the manic-depressive Mr. Market, who votes in the short-term and weighs in the long-term.

In this post-truth world we thought it was a good time to remind ourselves of some key objective facts that are integral in shaping the investment opportunity in emerging markets.

  • Population Factors: At the end of 2015 the world population was 7.4bn of which 85% lived in Africa, Asia or Latin America. Asia alone accounts for approximately 60% of the world population (Source: United Nations). By 2100, over 80% of the world’s projected 11.2bn people will live in Asia or Africa.  The UN predicts that half of the world’s population growth will come from just 9 countries (in order of contribution): India; Nigeria; Pakistan; Democratic Republic of Congo; Ethiopia; United States; Indonesia and Uganda.
  • The Demographic Dividend: The population growth noted above will eventually result in a material demographic dividend to these underlying economies.  Countries such as India and Indonesia are in the early phases of this but have long run times remaining. By way of example, the emerging and frontier markets on average had approximately 30% of their populations under the age of 14 at the end of 2015. Compared with 19% in the United States and 16% in the European Union.
  • Growing Wealth: The underpinning population factors drive economic prosperity, which translates into burgeoning consumer demand.
  • The Role of Corporate Governance: Poorly governed companies or those with weak alignments of interest to minority shareholders underperform the market over the long-term. Our proprietary research outlined in the working paper, “The Merits of Corporate Governance Focused Investing in Emerging Markets”, demonstrates that a material return premium is available without assuming any additional risk.
  • Fundamental Considerations: If investors do not appropriately account for the price paid for an asset you will underperform. This applies not only at the asset level, but, also at the fund manager level.

These facts anchor how we think and build investment portfolios.

In this quarter’s chart books, we outline a range of fundamentals in the emerging and developed markets which reinforce the compelling case for emerging market equities. None more so than the attractive valuations in the emerging markets. For example, on forward earnings multiples, and on a cyclically adjusted basis, the emerging markets offer compelling value relative to developed markets.  The cyclically-adjusted price to earnings ratio on the MSCI World Index is currently 21.3x versus the MSCI Emerging Markets equivalent of 9.4x.  While underlying profitability is on a par with that of the developed markets.

We also examined the performance of the underlying currencies comprising the index (for those currencies not pegged to USD). This has been a key contributor or detractor of returns in the short-term, given the material moves and heightened volatility. The stand-out, Egypt. In November, the Central Bank of Egypt took the decision to float its tightly controlled currency, which resulted in a 50% devaluation of the currency. The motivation for the devaluation arose from stringent requirements outlined by the International Monetary Fund, in order to meet requirements for a loan of $12 billion. While the stock market rallied on the news it was not enough to offset the devaluation, although this provided long-term owners with an opportunity to buy. In addition, those economies reliant on commodity exports saw a period of sustained currency strength as commodity markets settled after years of devaluation.  Indeed, the 5-year trend has seen all the emerging markets currencies weaken against the US dollar.

*Craig Mercer is co-founder and CIO of Remerga, an Australian emerging markets manager which focuses on governance and sustainability at the companies in which it invests.