NEW YORK — Emerging-markets investors may have done well for themselves during the past four years, but there are several reasons why they might want to exercise caution in the coming months, according to one portfolio manager.
NEW YORK — Emerging-markets investors may have done well for themselves during the past four years, but there are several reasons why they might want to exercise caution in the coming months, according to one portfolio manager.
In a note, “Emerging Markets — Seasonal Storms Ahead?” Vincent J. McBride, a partner at Lord Abbett & Co. LLC in Jersey City, N.J., and manager of the Lord Abbett International Core Equity Fund (LICAX), said that excessive global liquidity, paired with expectations and momentum in certain emerging markets, should be a warning for short-term investors.
“[Given] the powerful fund flows, the strong gains and the lofty valuations we’ve seen so far in the emerging markets, any significant change in the global growth (or interest rate) outlook could send some investors to the sidelines — so be careful,” he wrote in the report, published Feb. 28, just after the markets around the world plummeted due to sell-offs.
The drop is no surprise to Mr. McBride after the gains that the Russian, Chinese and Indian equity markets experienced last year, he said in an interview. “I think it’s healthy,” he added.
Of particular concern are the “lofty valuations” of those three BRIC markets, Mr. McBride said. Even smaller markets such as the Philippines, Indonesia and Mexico appear pricey lately.
“Parts of the emerging-market universe now look expensive to us on an earnings basis,” Mr. McBride said. “We feel that parts of the emerging market are fully valued. That means that they’re no longer trading at a discount to their intrinsic value.”
“Make sure that you’re taking a truly long-term approach to these markets,” Mr. McBride advised. “We think that it could be rocky for a little while here.”
“We need to see a bigger pullback to get very excited about emerging markets overall,” Mr. McBride said, adding that he doesn’t have any investments in India or Russia currently.
While he is cautious right now, he said, if such a pullback happens, he will turn positive.
Until then, Mr. McBride doesn’t suggest that investors take money out of the region. “They just need to put less in,” he advised.
“People should get paid to take risk in the riskier parts of the world, but we don’t think investors are being compensated to take risk in some of these more high-valued markets in the emerging-markets universe,” Mr. McBride explained.
Of note, he said, is that the Morgan Stanley Capital International Emerging Markets Index has dropped by 10% to 20% between February and June in seven of the past nine years.
In the long term, however, Mr. McBride has faith in emerging markets for investors.
“Indeed, growth in the developing world could be double the rate of the developed world for many years to come,”he wrote.
Robert S. Gay, a former Federal Reserve economist, agrees for the most part.
“[Equities] are way ahead of themselves,” said Mr. Gay, now a managing partner at Fenwick Advisers, a Rye, N.Y., investment advisory firm. “It’s a thin market with a limited amount of market cap being driven by huge amounts of liquidity in the world.”
China, Russia and India are in particular a special story, because they were all a focus of the carry trade in the yen, which is driven by excess liquidity, Mr. Gay said.
“It’s really a story about risk,” he explained. “If the world doesn’t end up to be a rosy scenario outside China, Russia and India, then their export stories aren’t as bright in the short run, and then their stocks are ahead of themselves.”
Furthermore, in certain countries, the risk isn’t worth it, Mr. Gay said. “In Russia, you’re not being compensated for political risk; political risk in Russia affects companies.
“I don’t think all of the emerging markets are expensive. The better-rated countries, and some of the commodity countries apart from Russia, still have some value.”
