🌎Macro#09: Emerging Markets Buying Opportunity? Don’t Miss Out On This 10-Year Trend Shift

Why Ray Dalio and Other Investing Legends Are Buying Emerging Markets

Sep 27, 2022

Source: Screenshot of MSCI Emerging Market, Buffet Taro

The US stock market has recently been one of the most popular investment options, with stellar returns outpacing almost any market.

This is clearly seen in the graph above. It shows a ratio of Emerging Markets divided by S&P500. In simple terms, if it is going up, Emerging Markets outperform US Markets and vice versa.

The yellow shaded area from 2001 to 2011 was when emerging markets outperformed the US market after the dot-com crash. Some of you may remember the BRICS movement.

The blue shaded area from 2011 to 2021 is where the US market outperformed emerging markets. This was primarily driven by the large tech stock boom on NASDAQ.

Looking at this graph, we can assume a certain number of things. First, the trend shift changes every ten years. And once the trend changes, it sustains for ten years.

Looking at the current graph, we might see that a 10-year trend is starting to change as the US stock market is crashing. And this may be a signal to investors for a buying opportunity in emerging markets.

Here’s why emerging markets are worth considering now.

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Stagflation in US and EU

There is a high chance of sustained inflation in the US until the mid-long term. Ray Dalio has mentioned that inflation can continue well into 4~5% until next year.

Ray Dalio Believes Majority of Wall Street Estimates are Wrong

“I estimate that a rise in rates…will produce about a 20 percent negative impact on equity prices”.

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(I know that some people disagree with this. Fed and Wall Street think 2%, Elon Musk and Cathie Woods think deflation).

The issue is that we also have a high risk of recession or negative GDP growth. The combination of inflation and low growth may well drop developed nations (US and EU) into stagflation.

“Stagflation will force investors to look for pockets of growth in the world, and emerging markets will be the first in line, especially those more immune from weakening global demand” — Trinh Nguyen, a senior economist at Natixis SA

The low projected returns have led many investors to explore emerging markets with higher growth and possibly returns.

What are Emerging Markets?

The term “emerging markets” was coined by Antoine van Agtmael in 1981. At the time, he worked for the International Finance Corporation (IFC), a division of the World Bank.

The IFC had collected data on ten markets and found that foreign investors might be interested in investing in these places but would be put off by the risk of investing in a single location.

The answer was to provide them with a one-stop, broadly representative “Third-World Equity Fund.”

When Mr. Agtmael pitched the idea to a group of fund managers at an event hosted by the Salomon Brothers, some were intrigued but hated the name. So he created the term “emerging markets,” which evoke “progress, uplift, and dynamism.”

And what exactly are they?

Emerging markets are defined as countries that are in the process of experiencing rapid economic growth and development.

Some examples of emerging markets include Brazil, China, India, and Mexico. These countries have all seen significant economic growth in recent years, and they are expected to continue to grow at a rapid pace in the future.

As a result, they offer a lot of potential for businesses and investors. However, with that said, there are also risks associated with emerging markets. For example, political instability or economic downturns could cause problems for businesses operating in these countries.

But overall, emerging markets offer much potential for growth and development.

The Case for Emerging Markets

Emerging markets could be a good hedge against stagflation due to the higher growth and inflation-adjusted returns.

Institutional and legendary investors recognize this and have been buying into emerging markets.

Source: Vanguard Asset-Class Outlook, September 2022

The above diagram shows Vanguard’s asset-class outlook for the next ten years by equity type. You can see that they believe global equities (below three) will have higher return projections. Please do note that the volatility or risk is higher for emerging markets unhedged equities.

Ray Dalio’s Big Position

If you look at Ray Dalio’s hedge fund’s top 10 holdings, emerging markets actually represent the third biggest position, just below P&G and JNJ.

Ray Dalio's Fund (World's Largest) Bought Huge Positions in 10 Stocks & Dumped Alibaba

Is the “China Bull” shifting away from China?

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Although he has offloaded some of his stake in emerging markets, I believe he is still bullish in the long term. He has recently opened an office in Singapore to strengthen his footprint in Asia.

Despite the current headwinds, such as strong inflation and weakness in US and EU that could decrease exports, developing countries with robust local demand may experience higher growth rates.

For instance, India is projected to have stronger economic growth than other major economies in 2023 as exports only account for 12% of their GDP. Even its stock market has managed to post some gains this year.

Also, some countries have hiked aggressively and already have lower inflation than interest rates. Therefore, you actually get a positive real yield, unlike in the US.

Beware of the Risks

However, we have to be extremely cautious. The Vanguard perspectives chart above shows that the median volatility or risk is extremely high for emerging markets.

And more importantly, we still don't know if now is the right time. The dollar is still rallying against other currencies, and inflation is still rising. Some developing countries are at risk of default.

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I don’t think there is any harm in waiting until the dust settles.

For example, Ray Dalio liquidated some of his emerging market positions last quarter.

How can you invest in them?

When it comes to investing in emerging markets, there are a few different options available to investors.

One option is to invest in ETFs, which are exchange-traded funds that track a specific index or sector. ETFs are a type of security that tracks an index, a basket of assets, or a commodity. There are many different types of emerging market ETFs available, so it is essential to do your research before investing.

Some ETFs track the MSCI Emerging Markets Index, meaning you will purchase in a basket of countries.

Some ticker symbols include the below (Ray Dalio owns both):

Vanguard MSCI Emerging Markets ETF (VWO)
iShares MSCI Emerging Markets Index ETF (EEM)

Another option is to select one country and buy an ETF following that specific country. For instance, if you want to invest in India, you could buy the below.

iShares MSCI India UCITS ETF USD (ACC)

You may ask, how can you pick one emerging country? But it all depends on your research and conviction.

When researching which countries are attractive, you can look at GDP growth, unemployment rate, inflation, foreign reserves, current account, currency depreciation against dollars, etc.

Another option is to invest in stocks from emerging markets or ADRs, which are American depositary receipts representing foreign companies' shares. Some examples are TSM (Taiwan Semiconductor Manufacturing Company), BABA (Alibaba), and JD (JD.com).

But remember, ADRs are extremely risky because local regulations can change the investment landscape quickly.

Finally, some investors make direct investments in assets such as properties in that particular country.

Each option has its risks and rewards, so it’s important to do your research before deciding which one is right for you. But the risk increases as you move down the list.

I prefer to buy a large basket of countries such as VWO or EEM.

Ultimately, your best option will depend on your individual goals and risk tolerance.

Conclusion

So, what’s the verdict? Should you invest in an Emerging market ETF now?

I think it looks attractive, but there are some risks to be wary of.

First, it is difficult to say if the timing is right now. Although Ray Dalio is bullish in the long term, he just offloaded some shares in the last quarter.

Second, how much should you allocate to emerging markets? Again, I believe you should consider it a hedge to your overall portfolio rather than going all-in.

“A proper global stagflation shock is unlikely to spare emerging markets, but insofar as stagflation-type risks are a spectrum, emerging-market opportunities can help hedge developed-market risks,” — Vishnu Varathan, the head of economics and strategy at Mizuho Bank.

This is not financial advice. I am not a financial advisor, and you should do your own research and not just listen to anyone on the internet. Nothing contained in this publication should be construed as investment advice.

If you want to read more about what other legendary investors, such as Warren Buffett and Ray Dalio, have been doing in the current downturn, click here.

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Inflated World