What’s Worked Lately in EM isn’t What’s Worked Long Term
Many investors see emerging markets as proxies for commodities, but within the space, the sectors that shine longer term are consumer discretionary, consumer staples and health, not energy and materials.
Over the last 10- and 15-year periods, the MSCI emerging market consumer discretionary, consumer staples, and health care sectors have massively outperformed energy and materials. This outperformance included the period when oil prices increased by more than six times at the start of the last decade. For each period, all three sectors outperformed materials and energy substantially (See Chart 1). Even the period from the start of 2002 to the end of 2007, when global commodities saw their largest rally in decades, the health care, staples, and consumer discretionary sectors delivered respective annualized total returns of 19.5%, 17.3%, and 22%, which was roughly in line with the index return at 20%, with substantially lower risk as measured by volatility than that experienced in the materials and energy sectors. While we acknowledge that from time to time this strategy can lead to underperformance, we try not to make decisions with short-term performance in mind and instead continue to evaluate the long-term ability of our holdings to compound through a variety of economic environments.
After the recent rally in emerging markets, we are seeing the lowest valuation relative to historical levels in Taiwan, Turkey, China, and Mexico. It’s also worth noting that rarely has Brazil been more expensive. While Brazil likely deserves some premium right now, as it recovers from its worst recession in the country’s history, the path forward is not without risk considering the difficult fiscal cuts required to slow the growth in Brazilian government debt.
From a sector perspective, we continue to see value emerge in consumer staples and consumer discretionary stocks, especially as the valuation gap has closed relative to the commodity sectors. As a result, we are optimistic that we are nearing the end of the performance differential between the higher-quality companies we like and the lower-return, indebted businesses that have led the markets for much of the last year.