Academics insist that stockmarket efficiency causes existing share prices to immediately incorporate and reflect all relevant information.
Fund managers tend to disagree about the immediate nature of the phenomenon. They try to gain an information advantage and benefit from it. Simply put, they try to develop ways to be ahead of the market and profit from this insight. They see short-term inefficiencies and mis-pricing as opportunities.
Looking at world equities today we can see a mis-pricing of such magnitude that it must have US economist Eugene Fama questioning his own ‘efficient markets’ theory that this information is all priced in.
Since mid-2011, global concern over the end of quantitative easing, an implosion (or is it explosion?) of the EU and a possible hard landing in China against a background of the collapse of shadow banking has led to money flowing into ‘safe haven’ developed markets equities. This in turn has driven the price-to-earnings (p/e) ratio for the MSCI World index from 10 to nearly 15 times.
Over the same period, global emerging market equities have not seen any noticeable multiple expansion whatsoever. The forward p/e for the MSCI Emerging Markets index has remained flat at roughly 10 times.
This means that developed market equities are now one-and-a-half times more expensive than they were in mid-2011 and are also one-and-a-half times more expensive than emerging markets.
Looking at p/e ratios may be seen as somewhat simplistic, and growth also needs to be taken into consideration. There again the rear view mirror does little to explain the developed markets premium: developed markets equities are yet to reach their pre-Great Financial Crash level of earnings. By contrast, emerging market equities have generated more than that for the last two years.
Looking forward, consensus earnings growth for next year for emerging markets is roughly 14 per cent, compared with 12 per cent for developed market equities. Two years out, analysts believe that both emerging and developed markets earnings will grow by 10 per cent.
Two things can happen in the next few years: either the world gets better or it does not. In the first case, it is very unlikely that a 50 per cent premium for developed market equities can persist in my view. If we are facing another global meltdown it is very likely that markets with the highest valuations will underperform.
In both these scenarios, emerging markets equities seem likely to perform better than their developed market counterparts. The only eventuality where the latter asset class could do better is if we were to witness a decoupling in earnings between emerging markets and developed markets. We are not in the camp that believes this is likely to occur, and looking at the historic correlation of roughly 90 per cent between emerging and developed markets’ earnings growth this seems a reasonable assumption.
We believe that, currently, developed markets are priced for ‘near-trend’ growth, whereas emerging markets are priced for little if any. Looking at world equities today we can see a mis-pricing of such magnitude that it must have Mr Fama banging his head against a brick wall.
François Zagamé is a fund manager on the multi-asset team at Old Mutual Global Investors
