The best returns might require investing in troubled countries and looking past the benchmark index to find some gems
3 min
The last time emerging markets were doing this badly the term “emerging markets” hadn’t been coined yet.
That spells opportunity, and the greatest spoils might go to those investors who are the boldest and also willing to look past that poorly-defined category. The benchmark for how emerging markets stocks are doing is a widely followed index maintained by MSCI that has returned less than 4% annually in the past five years, compared with nearly 12% for global equities and more than 15% for U.S. stocks.
Dig into any of those broad categories, though, and there are clear leaders and laggards. A whopping 65% of the MSCI All Country World Index’s market value, including nine of its top 10 stocks, were American as of the end of October. The MSCI Emerging Markets Index has been dragged down in large part since 2020 by China, where a housing crisis and a heavy-handed approach to technology firms by leader Xi Jinping have depressed valuations. Alibaba Group and Tencent Holdings were two of the world’s most valuable companies four years ago, before the tech crackdown.
If not for the massive surge of the MSCI index’s Chinese components in September on renewed stimulus hopes, the overall picture for emerging-markets stocks would be even worse. India, in no small part because it isn’t China, has seen huge foreign and domestic investor interest and now has the third largest weighting in the emerging-markets index. But it also is one of the world’s pricier markets .
Emerging markets outperformed developed market stocks in the century’s first decade as commodity prices boomed and the tech and housing bubbles dented the U.S. market. Today, though, they are much cheaper as a multiple of earnings, and not solely because of China.
Just buying an emerging-markets index fund and betting on the performance pendulum swinging back could be a decent strategy. Bolder investors might be able to do better: The most enticing opportunities are where skepticism is highest.
For example, Mexico and the multinational companies that use it as a base to sell products destined for the U.S. are in President-elect Donald Trump ’s crosshairs. Newly-elected leftist President Claudia Sheinbaum also faces violent drug cartels and protests over changes to the country’s judiciary. But the MSCI Mexico Index has gone absolutely nowhere, with a slightly negative return over the past decade and a forward price-to-earnings ratio of around 10 times—less than half that of the U.S. market.
And Mexico is pricey compared with South Africa, Brazil and Turkey, which fetch multiples on the same measure of about 9.8 times, eight times and five times, respectively. All three also face significant domestic problems and leaders who have mismanaged their economies. But even poorly-run countries can have long-term promise, and occasionally some short-term charms: Brazil’s dividend yield, for example, is about 6%, or five times that of the S&P 500 index.
Another way to profit as a savvy emerging-markets investor? By reading what is on the label and then ignoring it. MSCI’s benchmark has had an odd definition of what qualifies that mostly matters to professional money managers.
For example, both South Korea and Taiwan are major emerging markets, but their citizens are wealthier than those of developed Portugal or Greece. With leading high-tech companies like Taiwan Semiconductor Manufacturing Co . and Samsung Electronics , educated workforces and excellent infrastructure, they have more in common with neighbouring Japan, a developed market. MSCI cites market access issues that hold them back. That might still make them attractive places to invest, but the rapid growth a country enjoys by becoming modern, educated and wealthy—the sort of thing that has people so excited about India’s long-term potential—are now behind them.
Getting booted from the index can create anomalies too. Israel, which is richer than Britain or France , was included in the emerging-markets index until 2010 for what seems like geographical reasons. Then it went from being a notable emerging-markets investing destination to irrelevancy for many fund managers.
Because it is the only officially “developed” market in the Middle East, Israel is now part of the little-tracked MSCI Europe and Middle East Index created that year instead of the more-followed MSCI Europe, which dates to 1986. It is also a minuscule part of MSCI EAFE, which tracks 21 non-U.S. developed markets. With world class healthcare and tech companies like Teva Pharmaceutical Industries and Check Point Software in the index, “Startup Nation’s” stocks trade at barely half of the forward price-to-earnings ratio of the tech-heavy U.S. market.
And there are other stock markets just waiting to join, or rejoin, the official emerging-markets club. By the time they do the best gains might have been had. Take Argentina , which was demoted to “stand-alone” status three years ago because it was difficult to invest there. It has had a blistering return in dollars of almost 50% a year in the three years through October compared with a negative return for the MSCI Emerging Markets Index over that time.
While far from a foolproof investing strategy, betting that the last shall be first and buying what feels uncomfortable could pay off when it comes to beaten-down emerging-markets stocks.
Copyright 2020, Dow Jones & Company, Inc. All Rights Reserved Worldwide. LEARN MORE
The Australian leather house has opened an immersive four-day pop-up in Manhattan, unveiling its Bloom Collection and redefining what a product launch can look like.
Following the successful launch of its Palais Collection, MAISON de SABRÉ has unveiled a new modular handbag system offering more than 720 styling combinations.
Wall Street’s hottest momentum trade has reversed sharply, as former winners tumble and heavily shorted stocks surge.
3 min
Wall Street’s hottest trade has gone ice cold.
For years, it paid off to buy stocks that were rising in price—and bet against struggling shares. The momentum trade was especially profitable this year, as investors piled into hot stocks including Micron Technology, Nvidia, Advanced Micro Devices and other artificial-intelligence darlings while wagering against those likely to be hurt by the embrace of AI.
The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance.
Mega funds and rookie investors alike piled into the trade, some using leverage and options contracts in an effort to amplify their returns, propelling the underlying shares higher.
“It is a self-fulfilling prophecy,” said Matthew Tym, managing director at Cantor Fitzgerald, of the trade.
Suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second-worst month for the momentum trade in around 40 years, according to Bank of America estimates; the only month worse was April 2009, in the teeth of the global financial crisis.
Hedge funds that bought momentum shares while shorting low-momentum stocks suffered even more. At the same time, a basket of the most popular stocks held by hedge funds tracked by Goldman Sachs recorded its biggest one-month underperformance in July relative to the S&P 500 in more than 20 years, according to the bank’s analysts.
Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has.
“For decades, it didn’t take a lot of sophistication to run a momentum strategy and make a decent living at it,” says Agustin Lebron, senior researcher at EquiLibre, a trading firm.
Part of the reason: It takes a while for corporate and other information to spread to various investors, so they slowly build positions, producing buying momentum.
“A huge pension fund can’t flip around its positions in a day,” says Lebron. “Behavioral biases also account for some of the effect, as well—people tend to sell their winners too early and hold losers too long.”
Fans of the strategy point to the human tendency to extrapolate from past results—and chase investment returns—noting that momentum patterns have been evident in markets for decades, even centuries. They also say that some of the worst months for momentum strategies are during longer periods of outperformance.
Some have been doing the trade by buying the strongest investments in a sector while shorting the weakest; others lean in to rising markets or asset classes. Still others use a quantitative approach or turn to banks or others who sell ways to make distinct wagers on momentum as a “tradable factor” or a “thematic basket.”
The fans remain believers. “Any strategy has disappointing periods,” says Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management.
The surge in Moderna and other biotech stocks helped crush the momentum trade. These shares were among the most heavily shorted in recent years, but positive news on a cancer vaccine from Moderna and Merck sent those stocks flying, crushing some quant and other hedge funds. Moderna is up around 150% so far this month.
These traders had an especially rough day on Aug. 19, which Goldman Sachs told its clients was the worst day for “systematic long-short managers” in more than two years. About half of the losses were because of momentum trades, the bank said.
Some traders have begun to short, or bet against, the very stocks that propelled the momentum trade earlier this year. Net short positions in futures tied to the Nasdaq-100 index among speculators recently climbed to some of the highest levels of the past two decades, according to data from the Commodity Futures Trading Commission.
The about-face is a sign of how markets have become more treacherous for investors, even as indexes keep climbing. Part of the issue: the recent meltdown of Situational Awareness, a hedge fund that had piled into some of the most popular momentum shares, including chip stocks. After a period of market tumult, Nvidia shares rocketed almost 9% after its earnings, showing how quickly sentiment can shift.
Some investors say the run-up in share prices driving tech stocks higher reminds them at times of the dot-com frenzy decades ago.
Mike Ogborne, the founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is keeping more of his portfolio in cash than he typically does.
And he is nervous about the surge in spending by technology giants and quarterly capital expenditures that keep rising.
“It is a little bit like Cinderella and the clock striking midnight. You don’t know when midnight is going to come around,” Ogborne said. “They don’t send a memo around telling you when the capex cycle is over.”
