Emerging markets natural resource companies can be dirty companies, but they’re dirt cheap.
So says Research Affiliates’ Ryan Larson, essentially anyway, in the fundamental indexing firm’s June newsletter.
The Newport Beach, Calif., firm regularly emphasizes the return advantage of contrarian investment plays that involve selling popular high-performing stocks and buying unloved, poor performers.
The firm’s chief investment officer, Chris Brightman, made that point explicitly with reference to emerging markets natural resource companies in a debate with dumb beta proponent Rick Ferri.
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The pain of contrarian investment decisions, Brightman said Thursday, would be “like buying [Russian oil producer] Lukoil today. Does that feel like a comfortable trade? No. It means selling Internet stocks in the late ’90s, buying emerging-market resource stocks today.”
That pain, and potential gain, is described in greater detail in Larson’s analysis.
“Not since the Asian Contagion and Russian ruble crises of 1997–1998 have emerging market stocks underperformed U.S. stocks by as much as they have over the past three years,” writes Larson, noting a nearly 60% return premium for U.S. stocks versus their emerging-market counterparts.
“Through March 31, 2014, the three-year cumulative return of emerging market stocks as measured by the MSCI Emerging Markets Index is –8.35%, while that of U.S. stocks as measured by the S&P 500 Index is 50.73%,” he details.
Larson argues that two factors driving stock market returns over the long-term—mean reversion and valuations—both favor investing in emerging-markets, particularly its most battered natural resources sector.
As to mean reversion, net earnings in the U.S. are 50% above their historic average while they are 10% below trend in emerging markets. And, Larson adds, today’s globalized economy tends to homogenize profit margins from region to region, so one should not discount emerging-market earnings because they are not advanced economies.
As to valuations, using Shiller CAPE, the U.S. stock market trades at a multiple of 25 compared to a multiple of just 14, nearly half, in emerging markets.
The view is starker still on a price-to-book basis: “fundamentally weighted emerging markets portfolios trade near book value, levels touched in the depths of the Global Financial Crisis in February 2009.” Larson hastens to point out how well (fundamentally weighted) emerging markets performed in the immediate aftermath of the crisis, rising almost 150% from February 28, 2009 through end-year 2010.