More on the coming rotation out of DM and into EM

Since everyone is talking about the anniversary of the Lehman collapse and the financial crisis, now’s a good time to think about the upside after crisis. In February 2009, I wrote a post based on some advice from veteran investor Jeremy Grantham. It was pretty short, but here is the key kernel of his advice:

“When the market goes down, it reinforces the hoarding of cash. By the bottom, you suffer what we called in 1974 terminal paralysis — you cannot pull the trigger. Almost everyone who avoids the great pain is very slow to get back.”

The way I interpret his remarks are as a call to buck the gloomy consensus when the pain is reaching its worst. That way you are more likely to buy at the bottom than at the top. People probably thought he was insane at the time.

Timing wise, this was a couple of weeks early. But it was close to spot on. I wasn’t as sanguine as Faber back then. Yeah, I was asking the question: is the U.S. stock market close to bottoming? But my answer to that question was no; we would get a bear market rally but back in March 2008 I felt we would have another leg down.

It wasn’t until April 9th that I turned bullish.

So what about EM then?

If you recall, just six days ago I was writing, “As much as I would like to buck the bearish sentiment, I continue to see EM as an underweight, in currencies, bonds and equities.”

But I’m beginning to think about EM the way I thought about bank stocks in February and March 2009. That’s why I asked, “when will emerging markets begin to rally?” just the next day after my bearish note on EM. I said then that “if the US economy cools off, then the pace of expected rate hikes will likely fall. And the emerging markets would be off the hook… In a best case scenario, that means buying the emerging markets very soon.”

So I want you to look at this chart:

I’ve copied it below because it doesn’t embed on Patreon.

EM vs S&P500.png

This makes a compelling case for thinking about underweighting the US and overweighting EM in the very near future. I think this is the Jeremy Grantham thesis as he has been saying since early this year that EM is undervalued relative to the US. The problem I have with that view is that you need a catalyst to change directions. And there’s no reason to get out in front of this early rather than waiting for more bullish signals from EM or bearish signals from the US.

For example, the small business optimism index, at 108.8 is at its highest level since at least 1986. And the Republicans are talking about making individual tax cuts permanent in order to make gains at this year’s midterms and overcome the charge that tax cuts were just for the rich. It’s probably not going to happen, but the fact that it’s even being considered tells you we’re still in the up cycle in the US. Q3 GDPNow is still at a healthy 3.8% too.


I think it’s too early to rotate into EM. There are too many macro issues with emerging market economies and the developed market central banks are still tightening. Nevertheless, EM does represent a buying opportunity. And when the market sentiment begins to change, long-term gains there are a better bet than in S&P 500 companies. We’re just not there yet.


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