A globally prominent equity strategist has identified emerging markets as a favourite investment destination, and this has encouraging implications for Canadian investors focused on TSX stocks.
The bull case for developing countries made by Andrew Garthwaite of Credit Suisse is both extensive and compelling, and the good news is that domestic investors won’t have to take on the added risk of venturing into these foreign markets to benefit. History shows that outperformance of developing world markets translates directly to outperformance by the S&P/TSX Composite.
The first accompanying chart tracks a hypothetical $1,000 investment in both the S&P/TSX Composite and the MSCI Emerging Markets Index on June 30, 2010. The value of the investments track very closely, to the point where the difference, remarkably, is only $33 after a decade. The trend strongly suggests that Canadian equities will join any outperformance by developing world equities.
The primary reason for the close association between Canadian and emerging market returns is the resource-intensive nature of developing world growth. Compared with services-oriented economies in the developed world, emerging markets growth requires more commodities for every unit of GDP expansion. Emerging markets growth creates resource demand and higher commodity prices, benefiting the TSX’s large weighting in materials stocks.
Mr. Garthwaite’s bull case for emerging market stocks is based on non-Japan Asia. The pandemic hit the region first, and the area should lead the global economic recovery. The regional growth forecasts support this contention.
The second chart illustrates the relative economic growth forecasts for: Asia outside of Japan; Bloomberg’s G8 Index, which groups eight of the world’s leading industrialized economies; and China. The data show the average consensus estimates for GDP growth in 2020 and 2021.
The chart shows that growth expectations for China have stabilized at high levels while G8 expansion expectations continue to plumb new depths in negative territory. The forecasts for non-Japan Asia have taken a small step lower recently, but are relatively stable and much higher than the developed world growth outlooks.
Mr. Garthwaite also noted that emerging market equities are extremely cheap relative to the rest of the world. The third chart tracks the average relative price-to-tangible-book-value ratio for emerging markets relative to the MSCI World Index.
At the end of March, 2020, the price-to-book value for the global index was 5.2 times and the ratio for emerging markets was 1.8 times. So on these terms, developing world markets are trading at a 66 per cent discount to the rest of the world. This is the largest discount in the past decade.
Relative real, or inflation-adjusted, bond yields are another reason Credit Suisse believes emerging market stocks are set to outperform (not shown on charts). The strategist believes that U.S. Federal Reserve monetary support will result in a negative 2 per cent real yield in the 10-year Treasury bond. This will serve to drive the value of the U.S. dollar lower and make the local currency returns on both developing world and Canadian stocks more attractive to global investors.
Scott Barlow is The Globe and Mail’s market strategist.
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