The global market story of 2013 was clearly right here in the US, with total returns for the S&P 500 topping 30% (SPY ETF covering S&P 500 as of Dec. 23, Bloomberg). The other world markets offered a much more mixed picture. By comparison, EAFA (Europe, Australasia, and Far East) year-to-date performance came in at 18.8% (EFA ETF performance as of Dec. 23, Bloomberg). Returns were concentrated in the second half of the year in Europe, particularly for small-cap stocks. Which leaves the special conundrum of emerging markets. For investors in love with the emerging markets story, this was a dreadful year of love unrequited.
If you had to pick a country song to characterize emerging markets in 2013, you might reach back to the elder Cyrus (Billy Ray, not Miley, that is) and the lyrics to “Achy Breaky Heart.” In hindsight there is something a little bit unsettling about the whole thing (no line dance or mullet needed). Investors had been looking for the 2013 handoff of market recovery and leadership to extend outward from the US to other developed markets and then to emerging markets. Though they were an asset class that kicked off 2013 with some promise of recovery, the emerging markets never gained any traction in the earlier part of the year, extending their losing trend through June 26. Although the year-to-date return from the standard investable emerging market ETF, iShares EEM, is a disappointing -6.1%, that is just the achy part (as in “My joints hurt due to arthritis, but I don’t think I’m having a heart attack”). The breaky part is the volatility that accompanies the performance. From January 2 through Jun 26, EEM, which covers all emerging markets, was down 19.0%. There was then a flash-in-the-pan September/October recovery of 16.9%. Then, like an old soldier, the market just sort of faded away, with another 4.2% decline, breaking the hearts (and even some backs) of those who thought the emerging market recovery was imminent.
The big story in emerging markets, however, is the wide variation among them. Broad-based positions in emerging markets were not a source of profit in our accounts this year. At Cumberland we track 44 countries in both developed and emerging markets for consideration in our portfolios. (We look only at countries where there is an investable ETF that is suitable.) Although in totality the emerging markets were negative, there was also a barbell effect to the losses. Using MSCI Index returns, we see that China has a YTD return of -1.4% while Indonesia has a 26.9% loss. Taiwan has a 3.7% return while Turkey has a 24.4% loss. And such is the general picture, with China, Korea, Malaysia, the Philippines, Taiwan, Poland, and Russia showing slight gains or slight losses while other countries such as Brazil, Thailand, Indonesia, Chile, and Turkey have much more significant losses. Those are the sorts of variable performance found in 2013 emerging-country markets.
At Cumberland in our international ETF model we are at benchmark weight for emerging markets in general (approx. 20% of our International portfolio). We do not yet see a sufficient rationale for taking an overweight position. We continue to believe that country selection will be important for emerging market investments in 2014. The attractiveness of emerging markets on the whole in the coming year is still an open question. A recent BCA research report entitled “2014: The Year of EM Breakout or Breakdown?” concluded that emerging markets on the whole will decline further before a real buying opportunity emerges. In their view, EM equity valuations are not cheap at present. Other skilled market analysts reach a different conclusion, citing renewed clarity of Federal Reserve policy, which should free up risk-on investment to broaden the recovery to emerging markets. If that is the case, then a turning point could come in 2014, and so the overall attractiveness of the emerging markets as a block, index investment is now being watched more closely. We need to look carefully for structural or policy moves that will impart momentum (or even just a more consistent pulse) to emerging markets.
If the emerging market (EM) recovery never materializes and we see another year of mixed and negative returns, the year-end EM metaphor next December may have to further degrade to include something more akin to the younger Cyrus (this time of the punk mullet variety), wrecking balls, dances that rhyme with “jerk,” or any other sordid and sundry imagery. But we, like other market participants, think the potential for emerging market recovery is growing. We will watch closely the overall trend and individual country reactions to central bank policies, which have direct and powerful impacts on many of these country markets. Although 2013 has been a disappointing year for emerging markets, a stronger 2014 may be in the offing. We are looking for the emerging market recovery story to emerge sometime next year. If so, then next December when we write this year-end review, we may be able to revert to a different musical genre and a seemingly more innocent era, and join Patsy Cline in writing love letters in the sand.
This commentary was written by Michael McNiven, Portfolio Manager and Managing Director.