Shaping a Portfolio for 2017: emerging markets (ii)

Ex China, emerging markets are a motley crew.

MSCI Emerging Markets Index

countries

The MSCI Emerging Markets index consists of 23 countries.  At about 28% of the total, China is the largest component.  After that come, in order, South Korea at 15%, Taiwan at 12%, and India and Brazil at 8% each. The rest average 1.6% apiece.

sectors

The biggest sectors are IT and (mostly state-controlled) Financials, at about a quarter of the index each, and Natural Resources at 15%.

individual stocks

The five largest individual components of the index, comprising 15% of the total are, again in order:  Samsung Electronics, TSMC, Tencent, Alibaba and China Mobile.  All of these can be bought as individual stocks either in Hong Kong or in the US.

my take

To my mind, the most foreign investor-friendly country of the bunch is mainland China.  The rest are either not open to foreigners or are subject to the heavy hand of government control.  A big virtue of the index is that we can obtain exposure to 22 problematic places for foreigners to invest in one package and in a highly liquid form.

The big question is whether we want this exposure or not.  The merits of individual countries/securities aside, this has typically been a good thing when the world economy is expanding rapidly and when trade is in a high-beta relationship with overall growth (as it has been throughout almost all my investing career).  It has typically been a bad thing when the world is in recession.

At present, I don’t see the positive case as particularly compelling.  In addition, the high-beta relationship between trade and growth which has worked to the benefit of emerging nations for decades has been showing recent signs of breaking down.  So it’s at least thinkable that the payoff from taking the risk of investing in the more frontier-ish of these countries will be less than in the past.  Personally, I’d prefer to own developed markets + China right now.

 

 

 

Shaping a Portfolio for 2017: emerging markets

Let’s divide emerging markets into two categories:  China and the rest of them.

China

Measuring using Purchasing Power Parity, China is the largest country in the world.  It’s much faster growing than other large economic areas, like the US or the EU.  It’s also accessible to foreigners in several ways:  through Hong Kong-traded stocks, through China-centric mutual funds and ETFs and for individual mainland equities through connections among the Hong Kong, Shanghai and Shenzhen stock exchanges.

I have conflicting thoughts about China today.

The country is currently going through a transition from GDP growth through low value-added, export-oriented industries to expansion through consumer-oriented domestic demand.  This is never smooth sailing.  At the same time, two of its biggest export markets, the EU and Japan, have undergone massive currency devaluations.  This makes the transition more urgent–and potentially much more choppy, since China-sourced products are now much more expensive there.

That’s the near-term bad news.

On the longer-term positive side, the inward, anti-trade turn being signaled by the incoming Trump administration will, I think, mark the shifting of the mantle of world leadership–with its attendant pluses and minuses–from the US to China.  (To be clear:  although I think this may be the signature result of the Trump administration, I don’t think Mr. Trump intends this outcome;  he’s just clueless.  And the real cause is policy failure by the two major domestic political parties over the past decade or more.)

One plus will likely be a greater desire  by foreigners to own Chinese stocks and, because of this, a gradual PE multiple expansion for them.  A potential minus will be more pressure on Beijing to loosen Communist Party control over its financial institutions and its currency, which will subject the renminbi to the speculative ups and downs of currency traders.

My bottom line:  I mostly see bumps in the road for China in 2017.  I’m keeping a small China position, comprised of mutual funds and Macau casino stocks.  But I feel no strong urge to buy more.