Emerging Markets are starting to look attractive

A little history is important. Those clients that were with us in 1998 saw THOR invest a significant portion of their portfolio – 40%-45% – in international stocks shortly after the Asian currencies collapsed. It was a great time to invest. You had Asian stocks selling for half the value of US companies, but at twice the growth rate. The move to international stocks was swift because the drop was sudden and dramatic and our clients benefitted from this move. We reduced our exposure to international stocks to a neutral weighting a couple of years thereafter. About four years ago, we reduced our international exposure to an underweight position of 5%-7% of your portfolios – the lowest in our history. We are now beginning to see opportunities to add to our international stocks, especially the emerging markets.

The case for emerging markets over the past few years has been strong. Here are some of the most compelling reasons:

1. Emerging market economies are growing faster than the developed world.
2. Unlike the 80’s, the emerging markets do not have a government debt problem -the developed world does. Therefore, there is a chance for currency appreciation.
3. Average age of populace is much younger than the developed world.
4. Fewer regulations than the developed world.

All these points are legitimate. The problem for us to this point has been the price people were paying for the companies in the emerging market arena. The valuations of emerging market equities are starting to become more attractive. As the chart below shows, emerging market equities have lost -10.11% of their value since March of 2011, compared to a +24.45% return for US stocks. Emerging market stocks are down this year -2.46%. There is a dislocation between the US market and emerging markets. We are strong believers in reversion to the mean and the current excess returns of US stocks over emerging markets is an opportunity take advantage of such a move. Either US stocks will fall more dramatically than emerging markets if there is a correction or emerging markets will start generating higher returns than US stocks.

What does this mean for your portfolio?

We have already identified a fund in the emerging market arena to invest in. We are not using an index fund we reviewed because it owns Chinese banks which have not written off any bad loans in more than a decade (A great, but technical, book that addresses our concerns with Chinese banks is “Red Capitalism: The Fragile Foundation of China’s Extraordinary Rise”). The fund we have chosen is a fund that gains a majority of its earnings from selling to consumers in those markets. Our intentions are to start building a position in emerging markets in the near future in a measured way. Emerging markets tend to be more volatile than established markets and we will become more aggressive buyers if there is a significant correction in the stock market over the next few months.

Sincerely,

Your THOR Team