Emerging markets too hot? Try mature economies

AP News
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Posted: Dec 10, 2009 12:09 PM

Spicy numbers make it easy to see emerging markets' allure: The average Latin American stock fund has more than doubled this year.

Results are outsized anywhere you venture across the globe's emerging markets, to countries like China, Russia and Morocco. Their stocks are up an average 70 percent in 2009.

Gains elsewhere seem comparatively bland: 26 percent for developed markets outside North America, and 22 percent for the U.S. Standard & Poor's 500.

Sure, emerging markets risks can be big _ expect an occasional currency devaluation or government coup to send stocks reeling.

That hasn't scared away U.S. investors lately. By year's end, they will have poured $41 billion into international stock funds, according to a projection by the research firm Strategic Insight. Emerging markets funds are bringing in more than twice the developed markets total.

But 2009's rush into the world's upstart economies is enough to give bargain hunters pause _ have stocks risen so fast that good deals are now easier to find in less-volatile established markets?

That's the thinking of Sarah Ketterer, CEO of Causeway Capital Management, a Los Angeles-based manager of $10 billion, mostly in emerging and established foreign markets. She's also a co-manager of Causeway's $2.2 billion International Value Fund, a Morningstar analyst pick that's up 30 percent this year.

After nearly two decades in international investing, Ketterer has learned to be skeptical when others are rushing in.

"If you ask the man on the street now, he'll tell you, 'After this rally, it's much less risky in emerging markets than it was a year ago,'" she says. "I'd argue just the opposite."

"Given the precipitous rise in emerging markets, risk levels have also risen. Once you start paying full price, your risk is higher that you won't realize a return on your investment."

Ketterer doesn't yet see an emerging markets bubble. Long-term, she figures U.S. investors will generally fare well overseas, given emerging economies' richer growth expectations. And going global can smooth out the bumps in a portfolio, since overseas markets don't always rise and fall in tandem with those in the U.S.

But these days, Ketterer sees "slightly better" opportunities in developed regions, like Western Europe, and even Japan, whose economy has been in a two decade-long rut.

Excerpts from an interview on Ketterer's 2010 outlook:

Q: Where should investors be putting money now: overseas or the U.S.?

A: We still think the U.S. has interesting opportunities. But the opportunity set is bigger abroad, even if you exclude the emerging markets.

Compared with the U.S., overseas stocks tend to be priced less efficiently. (There's a mismatch between a stock's price and the underlying value of the company.) And that's even more the case in emerging markets. And price inefficiency creates investing opportunity.

Q: Do you think the emerging markets rally still has room to run?

A: Emerging market stocks have risen so sharply that their valuations aren't nearly as competitive as they were just a few months ago. You have to hand it to emerging markets _ most of them have evolved, and progressed to where disclosure about corporate earnings is much better than it was a few years ago. And quality of earnings has improved.

I don't expect a bust in emerging markets. It's just that the fundamentals ultimately dictate stock performance, and if investors have become too enthusiastic about emerging markets, then they may have a period of relative underperformance. It doesn't mean they're not good long-term investments.

Q: Which regions do you like in developed markets?

A: I couldn't even begin to tell you, because I don't think investing by geography makes any sense. I think it's a roll of the dice to put very concentrated country weights in a portfolio. What really makes sense is having a comprehensive understanding of an industry, and the winners and losers in that industry.

Q: Do you still like some of the industries that have fared so well in this year's rally, like technology?

A: We're de-emphasizing tech now in favor of sectors that haven't performed as well but are also very attractive. So we've increased our weight in defensive areas like health care and utilities. Those stocks have underperformed relative to their more cyclical counterparts, and look very appealing now.

Q: What about banks, which have rebounded so sharply from last year's plunge?

A: From March to September, they went from being near moribund to stars of the market. Their prices have run to the point where it's very likely you won't see the strongest performance from banks over the next year.

Our team at Causeway has had lengthy discussions on the regulatory risks banks still face, and the lending environment, and the two-year outlooks for bad debt. In many cases, it isn't very encouraging. We just don't see the relative attractiveness of banks now versus the investing alternatives we have.

Q: About 17 percent of your International Value fund was in Japanese stocks at the end of August. Japan has trailed global markets this year. What's your take on the world's second-largest economy?

A: We're not invested in Japan, as much as we're invested in several companies that are listed in the Japanese market and operate globally. Some of the larger ones, like Tokyo Electron, produce equipment for manufacturing computer semiconductors. Those companies sell around the world, and have very little to do with the Japanese economy.

As for Japan itself, it's still very relevant. I'm not bullish on Japan, but I don't think it's heading into the furnace like some suggest. There are world-beating companies in Japan.

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Questions? E-mail investorinsight(at)ap.org.