Mark Mobius, who manages $20 billion for Templeton Asset Management and who was recognized as one of the “Ten Best Investors of the 20th Century,” told investors a few weeks ago:
“We are at the base building period for the next bull market. What I see happening is perhaps this continuing till the end of the year, and then a break out.”
An outrageous prediction, right?
Well, it is and it isn’t.
After this week, most investors would consider it pretty aggressive. After all, this week the markets fell for the three straight days to start out the week. It was only the second time the markets fell for three consecutive days since the rally began back in March.
If we look at Mobius’ rationale though, his call doesn’t seem nearly outlandish.
The Great Reflation
It’s no secret the governments and central banks of the world have opened up the monetary floodgates to reinflate the global economy.
The United States has been leading the way. The Federal Reserve alone has committed more than a trillion dollars to monetizing the ballooning U.S. government deficit. Also, it has extended loans and guaranteed debt to the tune of $13 trillion. Most other countries have followed suit.
The U.S. Congress and presidential administration are following suit too. Congress just put the finishing touches on the “Cash for Clunkers” program (and stuck it into a defense spending bill to ensure its approval). This is yet another indirect subsidy to the carmakers by hoping to defray the costs of buying a new car.
Also, the $8,000 tax credit for first time homebuyers doesn’t seem to be doing too much to get the housing market rolling again. So now the solution is to up the tax break to $15,000 and open the deal up to practically every potential homebuyer.
It’s all part of the Great Reflation. The governments want to go back in time to a few years ago when all was “well.”
They want to reinflate the housing bubble. They want to take everything back to where consumers borrowed and spent too much, factories produced too much, and people were happy. They’re hoping to kick the can down the road far enough past the next election and they’re not going to let any natural economic forces stop them.
This is the key here. The government can keep things going for a lot longer than most people expect right now. And that’s a big reason Mobius continues to be bullish on emerging markets.
He recently summed it all up when he said,:
“The money supply is set to explode worldwide and boost emerging-market stocks as central banks pump cash into the financial system to counter the global recession.”
It’s already starting to play out in real time. The S&P 500 is up 2% this year. Meanwhile, the MSCI Emerging Markets Index is up 26%.
So where to from here for emerging markets?
The short answer is, if Mobius is right, there’s a lot of upside from here. Just look at the valuations.
After the worst year for MSCI Emerging Markets Index since it was created in 1969, there are a lot of compelling valuations despite the surge in value during this rally.
From a basic Price-to-Earnings ratio (P/E) perspective, emerging markets are still cheap. When the markets were setting new lows in March, the emerging markets stocks were sporting an average P/E ratio of 10. Now, despite the recent rebound, the MSCI Emerging Markets Index has a P/E of 14.
But hey, we’ve been over how utterly useless and unreliable P/E ratios have become. And if we look beyond the basic P/E’s, we see emerging markets are looking better than they have in decades.
For instance, the Price-to-Book Value (P/BV) is staggeringly low. A recent UBS Securities analysis of emerging markets puts the global P/BV at 1.5. That’s the lowest it has been since 1984.
Again, P/BV isn’t as reliable as an indicator it once was. The accounting rules are constantly changing and there are some similarities between now and then, but there are plenty of differences too.
There is, however, one ratio that that doesn’t lie; the dividend yield. Earnings can be manipulated. Book values are a questionable representation of actual asset values. But a dividend yield is a great ratio indicator. You can’t pay dividends with earnings or inflated asset valuations; you have to pay them with cash. That’s why right now, with the global dividend yield on stocks at 4% (the highest it has been in 25 years) makes emerging market stocks even more compelling.
An Inflection Point
In the end, we’re in the third and final stage of a bear market rally. All the telltale signs we identified a few months ago are there. For instance, the divide between bulls and bears is growing ever wider. In fact, you can put most investors into three camps.
Some investors are waiting for a pullback before wading back into the markets. Some saw it happen this past week and some are waiting for a full 10% correction in the developed markets and another 20% in emerging markets.
Plenty more investors are as bearish as ever. They cite the inevitable rise to 10% unemployment, declines in transportation activity, and increasing uncertainty over government regulation in banking, healthcare and energy.
Some others, which Mobius appears to be a part of, see how many bears are still out there and are placing contrarian bets. This is more of a fundamental approach where most of the problems are viewed as already “priced into stocks.”
In the end, I see a good bit of upside in a few spots (one of those is international stocks). The governments of the world have proven their willingness to print money, borrow and spend, and offer costly incentives to spark demand at almost any cost.
Over the long-term, these efforts will be proven futile. And there the next year or two will are a great opportunity to start preparing for the eventual consequences like an L-shaped recession, currency debasement, and a stagflationary economic environment. In the interim, however, there will be plenty of opportunities along the way and I wouldn’t give up looking for them just yet.
By Andrew Mickey