A theme that looks obvious in hindsight (as all themes do) is the outperformance of the U.S. vs. emerging markets in 2013. SPY is up almost 20% in 2013, while EEM is down more than 10%. In fact, the SPY / EEM ratio is close to 7 year highs (red line drawn around 4.50) at the moment:
The ratio has been rising, indicating U.S. outperformance, since late 2010 in fact. But it has really picked up the pace in 2013, rising more than 30% year-to-date.
The ratio is at an obvious short-term inflection point, but what’s the likely long-term direction? Much has been made of the resurgence of the U.S. vs. the stagnation globally, but as with most investments in the long run, what matters more is the relative valuation differential of the stocks. In other words, is the U.S. still cheap to at least fair vs. emerging markets, despite the huge move?
A few comparisons as I look through the major components of EEM and SPY:
- Samsung is a 10 P/E name expected to grow earnings 10% per year over the next 2 years. AAPL is a 12 P/E name expected to grow earnings 10% per year over the next 2 years.
- Taiwan Semiconductor is a 15 P/E name expected to grow earnings 12% per year over the next 2 years (3% div). INTC is a 12 P/E with no expected earnings growth over the next 2 years (4% div).
- China Mobile is a 10 P/E name with -2% earnings contraction over next 2 years (4% div). AT&T is a 15 P/E name with 8% earnings growth expected over next 2 years (5% div).
- Tencent Holdings is a 39 P/E name with 25% expected earnings growth over next 2 years. GOOG is a 26 P/E name with 15% expected earnings growth over the next 2 years.
- Gazprom is a 2.5 P/E name (not a typo) with 5% expected earnings contraction over the next 2 years (5% div) CVX is a 10 P/E name with flat earnings expected over the next 2 years (3% div)
- Petrobras is a 10 P/E name expected to grow earnings 10-15% per year over the next 2 years. XOM is a 11 P/E name expected to grow earnings 0-5% per year over the next 2 years.
I left out the banks because of the difficulty of valuation comparisons there. However, I will note that I would much rather own U.S. banks than emerging market banks (particularly Chinese banks), as I do think that’s one area where the balance sheets are much more dangerous in the emerging markets than in the U.S.
But for the remaining company list above, if I were simply given these valuation / growth comparisons, I would prefer the emerging market company to the U.S. company in every instance, with the exception of AT&T over China Mobile. Obviously, these are simplistic comparisons, as the businesses are much different, with various obstacles and opportunities. At the end of the day though, earnings are earnings, however earned, so valuation comparisons are still relevant.
The valuation differential is starting to favor emerging markets. The bad news there seems to be more than priced in on a relative basis. However, psychology is the driver in the short-term. The U.S. overweight has worked for investors this year, so they’re content to stick with it for now. My hunch, though, is that the SPY / EEM ratio above will have a hard time getting through 4.50 unless a more major shift affecting global markets occurs.