China and Emerging Markets

China is closed. The world’s second-largest economy is shut down due to the Coronavirus, and life is at a standstill. According to several news reports, the number of deaths from the virus has now surpassed the number of deaths from SARS – a frightening thought, and the uncertainty is making the situation worse.

China’s idleness will have, at some point, an impact on global economies and stock markets. The Chinese stock market is down .5% for the year, but this can change quickly.

Emerging markets and China are linked. Chinese stocks are 33% of the MSCI Emerging Market Index, so when China moves, so does the index. The index invests across five regions, 26 countries, and 1,100 securities.[1] Dimensional Funds, Fidelity, and Oppenheimer manage sizeable emerging market mutual funds, while Vanguard, Blackrock, and Schwab have substantial assets in their exchange-traded funds. The top holdings for most of these funds include Alibaba, Tencent, Taiwan Semiconductor, and PingAn Insurance Group.

The Matthews China Investor Fund (MCHFX) has produced an average annual return of 11.51% for the past twenty years, and it has a current asset allocation of 95% stocks, 5% cash. Most of their assets, 89%, are invested in Asian emerging markets.

Chinese stocks account for 3% of the global equity market capitalization, the same level as France and Canada.[2]  We recommend an allocation of 5% to emerging markets, so if Chinese stocks account for 33% of the index, our exposure to China is 1.65%. If Chinese stocks fall, the index will too. However, I’m willing to commit 1.65% of capital to the world’s second-largest economy.

During the AIDS epidemic from 1987 to 1995, the emerging markets index fell 6.7%, Chinese stocks dropped 40%, and the S&P 500 rose 34.9%.

Emerging markets rose 13.8% during the Bird Flu outbreak from 1997 to 2004. Chinese stocks plunged 65.6%, the S&P 500 rose 63.6%.

The emerging markets index rose 122% during the SARS epidemic from 2002 to 2005, while Chinese stocks climbed 74%, and the S&P 500 index grew 8.7%.

During the Swine Flu outbreak from 2009 to 2010, emerging markets soared 103.1%, Chinese stocks increased by 62.5%, and the S&P 500 was up 39.2%.

The Ebola outbreak occurred from 2013 to 2016. During this outbreak, emerging markets fell by 18.2%, Chinese stocks dropped 6.8%, and the S&P 500 rose 57%.

The United States stock market is massive, efficient, and developed, but it’s not immune to extended periods of poor performance. During the ‘70s, a 10,000 investment grew to $11,570, generating an average annual return of 1.47%. If you invested $10,000 in the S&P 500 on January 1, 2000, you had to wait thirteen years before you were profitable. But, if you held on to your original $10,000 investment from 1970, it’s now worth $357,820, producing an average annual return of 7.35%.[3]  For the past two decades, the S&P 500 and MSCI Emerging Markets Index produced similar returns.

Emerging markets have always been volatile – a feast or famine mentality. In 2006, Chinese stocks rose 82.9%. in 2008, they fell by 50.8%. Turkey rose 253% in 1999, and fell 45.8% in 2000, 32.8% in 2001, and 35.8% in 2002.[4] Volatility is the central theme for investors in emerging markets.

Does it make sense to sell all your emerging market holdings? My recommendation is to stay committed to this sector. Another reason to remain long emerging markets is demographics. China, India, Indonesia, Pakistan, Brazil, Russia, and Mexico account for 49% of the world’s population – and growing![5]

Rather than selling your emerging market stocks, invest in a globally diversified portfolio of low-cost funds, investing in an assortment of stocks and bonds based on your financial goals and time horizon.

What should you do if emerging markets fall? Buy more!

Nevertheless, I will bring health and healing to it; I will heal my people and will let them enjoy abundant peace and security. ~ Jeremiah 33:6 

February 10, 2020.

Bill Parrott, CFP®, CKA®, is the President and CEO of Parrott Wealth Management located in Austin, Texas. Parrott Wealth Management is a fee-only, fiduciary, registered investment advisor firm. Our goal is to remove complexity, confusion, and worry from the investment and financial planning process so our clients can pursue a life of purpose. Our firm does not have an asset or fee minimum, and we work with anybody who needs financial help regardless of age, income, or asset level. PWM’s custodian is TD Ameritrade, and our annual fee starts at .5% of your assets and drops depending on the level of your assets.

Note: Investments are not guaranteed and do involve risk. Your returns may differ from those posted in this blog. PWM is not a tax advisor, nor do we give tax advice. Please consult your tax advisor for items that are specific to your situation. Options involve risk and aren’t suitable for every investor.

 

 

 

[1] https://www.msci.com/emerging-markets

[2] Dimensional Fund Advisors 2019 Matrix Book

[3] YCharts.

[4] Dimensional Fund Advisors 2019 Matrix Book

[5] https://www.internetworldstats.com/stats8.htm

What’s an Emerging Market Anyway?

The talk around the water cooler lately has been to invest internationally especially in emerging markets.   What does emerging mean anyway?  Webster’s dictionary describes emerging as “newly created or noticed and growing in strength or popularity, becoming widely known or established.”   Sounds good to me but what does it have to do with investing?  Plenty.

Most investors will invest in established or developed markets like the United States, United Kingdom, Germany, Japan, Australia or Canada.   Established markets have several things in common like contract law, stable governments, and a modern infrastructure.   The citizens of these countries reap the benefits of a modern society by spending their wealth on fine dining, big screen TVs, huge homes and expensive cars.   Clean water and (mostly) affordable health care is available to all.

Emerging markets are defined by the BRIC’s: Brazil, Russia, India and China.  Other countries include Peru, Thailand, South Africa, Chile, and Turkey.  These markets typically have unstable governments, poor infrastructure and impoverished citizens.

I’ve had the good fortune to travel to a few emerging markets like Hungary, Haiti, Nicaragua and parts of Mexico.   In Haiti, the poverty is inconceivable.   The corruption in the government has stripped the land bare and left its citizens in misery.   The homes, roads and cars are in despair.  It will be centuries before Haiti is an emerging market, unfortunately.

Why should you invest in an emerging market?  A good reason is because they’re emerging.   They’re growing.  The rise of the middle class is giving these people access to things we take for granted like jobs, microwaves, washers and dryers, and iPhones.   It’s also giving them hope.  The advancement of technology is making our world smaller and richer.   As these markets begin to prosper so, too, will their citizens.

How much should you allocate to an emerging market portfolio?  I’d recommend a 5% to 10% allocation.   Here are three popular index funds you should consider for your portfolio.

  • Dimensional Funds Emerging Markets Portfolio (DFEMX). Year to date this fund is up 17.91%.
  • Vanguard FTSE Emerging Markets Index Fund (VWO). Year to date this fund is up is up 12.94%.
  • IShares MSCI Emerging Markets ETF (EEM). Year to date this fund is up 14.42%.

The 2017 returns for these funds are stellar and outperforming the Standard & Poor’s 500 index.  However, emerging markets carry risks.   The volatility for emerging markets is high.   The standard deviation for emerging markets is 28.7 by comparison the developed markets have a standard deviation of 17.4 a 65% difference![1]   In 1998, the Turkey market returned 252% while the Russian market lost 83%.   Last year Brazil was up 67% and Egypt was down 11.4%.[2]    The divergence in returns from year to year is vast and therefore an allocation of 5% to 10% makes sense for most investors.

As you construct your portfolio add a pinch of emerging markets.   The allocation could give your portfolio a boost.

It’s a small world, but I wouldn’t want to paint it. ~ Steven Wright.

Bill Parrott is the President and CEO of Parrott Wealth Management and is a fan of global diversification.   For more information on financial planning and investment management, please visit www.parrottwealth.com.

Note:  Your results may differ than those listed in this blog.  This is not a recommendation to buy or sell the securities listed in this blog.

 

 

[1]Morningstar Office 2017 Market Assumptions.

[2] Dimensional Funds 2017 Matrix Book