Global Consumer Index Signals Emerging Markets Are The Place To Be, But Not Yet
Since the Global Financial Crisis of 2008/2009 and certainly since the Euro Crisis of late 2011 investing has been largely dominated by swings in investor sentiment that can be defined as “risk on” and “risk off.” Emerging markets equities have been categorized as ‘risky’ assets by global investors.
This is, I believe, inappropriate but it is exhausting to instruct the market as to how to think about investments and I have largely resigned myself to understanding opportunity in whatever investing environment the market decides to provide.
Just to get on my soap-box for a minute: I can not believe that investors consider investing in countries where growth is higher, balance sheets are better, demographics are more compelling and the overall environment more conducive to economic growth to be ‘risky.’
It is equally incomprehensible that investing in countries where growth is lower, balance sheets are overstretched (at the national, company and individual level), populations are aging and the environment for growth is less attractive is ‘less risky.’ But it is not for me to decide what people think–just to understand it and watch for shifts in sentiment.
We have developed a proprietary Global Consumer Sentiment Index (GCSI) that combines sentiment indices from 25 countries. we are able to construct the index back to 2001 and track developments and changes in sentiment and market reaction to global sentiment.
There is a tight connection between sentiment and the performance of emerging market equities. Studying the trends in this index and markets allows us to better understand global investor risk appetite.
We have found that when there is a shock to the system consumer sentiment in many countries falls to ‘panic” levels (which we define as sentiment more than 1 standard deviation below the norm). after the Lehman collapse 72% of countries fell to ‘panic’ levels and after the late 2011 Euro Crisis 56% of countries reached ‘panic’ levels.
When sentiment is at ‘panic’ levels investors react to news flow (both positive or negative) and do not focus on valuations or relative value. These times remind me of the Keynes quote: “There is nothing so disastrous as a rational investment policy in an irrational world.” — John Maynard Keynes
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Fortunately, reason does eventually prevail, sentiment does improve and getting the timing of this right is critical. we have spent time analyzing these rebuilding phases and have developed a framework for predicting the trend in rebuilding.
Using this framework we are able to predict when sentiment returns to normal barring another shock to the system. Currently there are 10 countries where sentiment is at ‘panic’ levels (including the U.S.). unless there is another shock to the system (like an attack on Iran that spikes oil prices, a sudden implosion of the euro zone or some other unexpected shock) we expect that sentiment will be back to a rational level with just a couple of countries at ‘panic’ levels by October of this year.
As sentiment returns to normal from being dominated by ‘panic’ we believe investors will look at Emerging Markets and appreciate the growth, value, strength and outlook that they represent.
We are currently recommending to our clients that they begin to build positions in emerging market equities in anticipation of this return to more rational investing later in the year. there will likely be volatility in coming weeks and months so we are not recommending jumping in immediately or all at once but rather building positions slowly.
Below is a chart that we developed recently for clients that shows the relationship between our GCSI and emerging market equities and our outlook for sentiment in the coming months. I think you will agree that even if we are just a little bit right investors would be wise to look at emerging markets more rationally in coming weeks and months.