Morningstar Advisor - December 2013/January 2014 - (Page 42)

Spotlight Shifting Sands in Foreign Equity Markets By Kevin McDevitt Five years from the nadir of the global financial crisis, U.S. commentators have focused their postmortems mostly on what has happened in the United States. While the shifts here have been tectonic, everything from a rethink of housing to unprecedented Federal Reserve intervention, the upheaval in financial markets has been just as significant overseas. In some ways, the remodeling outside of the United States has been even more fundamental. Emerging Markets: Beyond Oil and Ore What these changes mean for investors is that they may need to redraw their mental maps of overseas markets. Nowhere is this more true than in emerging markets. Many long-held assumptions about emerging markets no longer apply. For years, many thought of emerging markets as fairly homogenous economies dominated by commodity-oriented sectors. But overall, emerging markets are now less driven by those sectors. In October 2008, energy and materials stocks consumed nearly a quarter of the MSCI Emerging Markets Index. Today, that combined weighting is below 20%. Instead, less commodity-focused firms have become much more prominent in emerging markets. Technology firms have made some of the biggest strides, with Samsung, Taiwan Semiconductor TSM, and TSM, Tencent now qualifying as three of the five largest companies in the MSCI Emerging Markets Index. Branded Companies Thrive One common theme across markets has been the increasing prominence of consumer-goods companies. Even as growth has slowed in emerging markets, many consumers there now have the disposable income to spend on branded products. The shares of European upscale spirits companies Pernod Ricard RI and Diageo DEO have doubled during the past five years, thanks largely to their growth in emerging markets. Such stocks now count for a larger share of the major indexes, both developed and emerging. Consumer discretionary and consumer staples stocks combined now account for 17% of the MSCI EM Index up from 11.5% in 2008. 42 Morningstar Advisor December/January 2014 Financials Share of Emerging World Sure, the share prices of U.S. and European financials have begun to recover after being decimated by the crisis. Bank stocks such as Wells Fargo WFC and JPMorgan Chase JPM in the U.S. and Lloyds Group LYG and Credit Suisse CS in Europe have all rebounded since 2008. But, at least in the developed world, financials still claim a far smaller share of their respective indexes. Whereas financials accounted for 30% of the MSCI EAFE Index in early 2007, today they're less than 26%. The decline has been even more pronounced in the United States: Financials account for just 16% of the S&P 500 after claiming more than 22% of the index in early 2007. It's a different story, though, in emerging markets. With economic growth there creating greater demand for financial services, that sector has increased its share of the MSCI EM Index to more than 26% from 21%. Price Multiples No Longer Depressed After the crisis, the U.S. rebounded more quickly than other developed markets. The road out of purgatory was slowed significantly in Japan and Europe because of the Fukushima disaster and Greece's debt crisis in 2011. With foreign stocks on a slower trajectory, their shares looked comparatively cheap heading into 2012, especially those in Europe. At the Morningstar Investment Conference that June, Leuthold's Doug Ramsey said that European stocks were the cheapest they had been in decades. Indeed, the average stock in the MSCI Europe Index was trading at just 10 times earnings. Those who acted on Ramsey's advice have plenty to smile about, with the MSCI Europe Index up 42.7% since then versus the S&P 500's 37.4% gain. Not surprisingly, European stocks are no longer the bargain they once were. The average P/E for the MSCI Europe Index is now above 15, its highest level since year-end 2006. Kevin McDevitt,CFA, is a senior fund McDevitt,CFA, analyst on the active funds research team for Morningstar. Russia, on the other end, looks like the strongest of the pack, thanks to a currentaccount surplus, a small influx of hot money, a mighty stash of foreign exchange reserves, and a mild excess of credit growth. China, often the focus of concern of many global macro commentators, is well down the ranking of vulnerability. (That, I would argue, is not because China is a safe haven, but because its macroeconomic Achilles' heel are domestic, not external, imbalances.) Any assessment of vulnerability to a capital freeze is bound to suffer from omissions, mismeasurement, and arbitrariness. I might not have included all the indicators that matter, and not all the ones I use might make a difference. It is also difficult to draw the line that separates the critically vulnerable from the merely fragile. Moreover, my metrics partially overlap, leading to exaggerating the degree of vulnerability for high-risk countries and underestimating it for the low-risk ones. I believe, however, that my compass is adept at assessing the relative degree of vulnerability within the group. This exercise may also inform more systematic analyses of country risk for investment decisions, and provide a reference point to country rankings produced by more sophisticated methodologies. Countries with extreme scores, especially those with high vulnerability scores across several factors, should be approached with caution. Navigators of the financial seas, ye have been warned. K Francisco Torralba, Ph.D., CFA, is an economist with Morningstar Investment Management.

Table of Contents for the Digital Edition of Morningstar Advisor - December 2013/January 2014

Morningstar Advisor - December 2013/January 2014
Contents
Contributors
Letter From the Editor
What’s Your Purpose?
Working for Gen Y
How to Allocate College Savings
Mobius Looks to a New Frontier
Investments á la Carte
Investment Briefs
How to Manage Bonds for Today and Tomorrow
Cloud Is the New Engine of Growth
Knowing Where to Look
Economic Vulnerability Varies by Country
Factor Investing in Emerging Markets
Following the Rules
Exploring Indexing’s Next Frontiers
Frequent Fliers
Family Blind Spots
Optimal Portfolios for the Long Run
Finding Value in a Pricey Sector
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Emerging-Markets Roller Coaster

Morningstar Advisor - December 2013/January 2014