Wednesday, May 15, 2013

Time to Exit Emerging Markets Stocks?

Global Equity Strategist Richard Bernstein was out yesterday in the Financial Times with an interesting column comparing US small cap stocks with emerging markets.

Bernstein - who in my opinion is one of the better strategist out there - discussed the fact that more investors seemed focused on the emerging markets as opposed to U.S. small cap stocks.

To be sure, small cap stocks have enjoyed a strong run recently. Bernstein To be sure, small cap stocks have enjoyed a strong run recently. Bernstein writes that over the last five years US small cap shares have risen nearly 50%,while investors in emerging market equities have lost a tiny -0.1% through the end of April 2013.

Bernstein thinks that small caps should continue to do better, however.  Here's what he said:

Profits data increasingly refute the widely held belief that the emerging markets offer the best growth.

Approximately 60 per cent of EM companies reported negative earnings surprises for the fourth quarter of 2012. The comparable figure in the US was only 27 per cent.  Earnings expectations for EM companies seem much too optimistic.

In addition, the projected earnings-per-share growth rate for US small-cap stocks is double that for EM stocks. Based on data from Bloomberg, the projected 12-month earnings per share growth rate for the S&P Small Cap 600 is 34 per cent, whereas the comparable number for the MSCI Emerging Markets universe is only 17 per cent.  US domestic stocks currently offer better growth and are certainly under-owned.
There's another reason to be worried about emerging markets stocks.

My friend Bob Quinn - who is also a regular reader of Random Glenings -  forwarded me a strategy piece authored by David Zervos, Global Fixed Income Strategist at Jeffries.

Zervos recalls the late 1990's, when Japan undertook a massive government program along the lines of current efforts in an attempt to try to weaken the yen to spur economic growth. 

Here's what Zeros writes:

But stability in Japan did not come without some catastrophic side effects. Along the way in 1995-1998, Japan's export competitors were destroyed. While the BoJ got religion, the move in USDJPY from 80 to 140 crushed nearly all NJA countries. Indonesia, Thailand, Malaysia, Korea and finally Russia dropped like dominos. The important lesson here is that when the Japanese decide to turn the ship around and go for it, the wake generates a tsunami for ALL mercantilist nations. Of course, it was a home run for non-mercantilist consumption junkies like the US - we enjoyed a massive positive terms of trade shock that everyone misinterpreted as a productivity miracle. The 90s in the US was about every one of the nations we import from stepping over themselves to stock the Walmart shelves with cheaper stuff. It was then that Goldilocks became an icon and the Maestro was born. Good days for the US but a disaster for every EM exporter across the globe. The moral of this story is don't underestimate how significant a massive turn by the BoJ can be for others. What is happening right now is a rerun of 95-98 in Japan. The BoJ has religion - AGAIN!! Its great news for the US, and terrible news for export driven EM. It may not last if the BoJ gets cold feet as it did in 00s, but right now there is NO reason to stand in the way of this massive policy change, and there is every reason to run with it!!

The trade that Bernstein suggests - from emerging markets stocks to the US small caps - is beginning to make sense.