If you’re a long-only equity investor and would like to beat the S&P 500, you only have two blunt force options: Tilt your stock portfolio to mid-caps and small-caps, or tilt it toward international developed and/or emerging markets. That’s it. You can’t really beat the S&P 500 any other way. It’s been well documented that small-caps are witnessing an extreme disconnect against large-cap performance, and a lot of people are ready to pounce on small-caps whenever (and if) momentum comes back. However, I believe it’s time for an international tilt.
For more than a decade, people seem to have completely forgotten about broad-based emerging market proxies. Right now I see pure apathy about international developed and emerging markets — even with China having (I believe) economically bottomed. Why are people so uninterested? Because for 13 years, emerging markets have dramatically underperformed U.S. markets. On an absolute basis, it’s been a disaster (and worse after inflation).
But I do believe cycles still exist and that the U.S. cycle will come to an end. In fact, we might be at that turning point now. When I look at the price ratio of emerging markets broadly relative to the S&P 500, it does look like maybe, just maybe, the ratio has bottomed. The U.S. and emerging markets have performed in line with each other since February, which reflects a potentially huge shift in sentiment — one that should not be ignored.
Unpopular equals opportunity
To be fair, there have been plenty of times where the chart looks like it bottomed, only to subsequently reach lower ratio lows. This is consistent with my belief that AI mania in the U.S. will ultimately end U.S. large-cap dominance on the global equity stage. Nevertheless, as things stand today, no traditional investor is even considering allocating to Brazil and China, given the two countries’ disappointing equity performance. No financial advisor wants to show their clients they bought a China-centric fund when all anyone wants is Nvidia (NASDAQ:NVDA).
But that may be precisely why there’s tremendous opportunity in emerging markets stocks.
Key to this will be what the dollar does next. One reason emerging markets have fared so poorly is because the dollar bottomed in 2011 and has been in a broad uptrend since. The dollar softening would provide a tailwind for anything international. And if that momentum begins in emerging markets, there could be big gains ahead.
Time to emerge? I hope so. It would make beating the S&P 500 so much easier.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
On the date of publication, the responsible editor did not have (either directly or indirectly) any positions in the securities mentioned in this article.
