Emerging Potential
Carta MAIG 2024 - Alkimia?
Carta MAYO 2024 - Alkimia Capital
Carta MAI 2024 - Alkimia Capital
?The past month has continued the upward trajectory of the markets, with the narrative around artificial intelligence capturing the focus of investors. We find ourselves in a situation where, progressively, a few companies are concentrating the euphoria and returns, with Nvidia as the prime example, contributing 42% of the total return of the S&P 500 by the end of May. If we compare this American stock market index to its equal-weighted equivalent (where all companies are equally weighted and not by market capitalization), the return drops from 11.3% to 5.5%, indicating that many companies are lagging in the market. This is not an unusual situation historically and has often ended poorly for investors. As George Soros noted, " stock market bubbles don't grow out of thin air. They have a solid basis in reality, but reality as distorted by a misconception." The market's faith (and perhaps greed) is placed in a few names, while a large segment of the market remains ignored. In this threat lies the opportunity to select investment ideas for our clients with the aim of outperforming the market.
Concentration of returns: S&P 500 vs S&P 500 Equal Weighted
Once again, we want to remind you how long-term prices and fundamentals tend to converge, creating opportunities for those investors with the discipline and courage to move away from the consensus. At Alkimia we believe that a rigorous investment process, paying particular attention to valuations (the price we pay for assets), will allow us to benefit from the inefficiencies generated by the market in the short term. Consequently, we think that today there is an opportunity in the equity of the emerging region, strongly punished in the last decade and where Alkimia's portfolios are overweighed.
Main market returns: 04/30/24-05/31/24
The recent history of emerging markets in the 21st century could be described as a tale of two distinct decades. The first decade is characterized by extraordinary stock market performance, driven by exceptional circumstances. China's entry into the World Trade Organization (WTO) in 2001 accelerated globalization as the country significantly increased its share of global exports. Between 2000 and 2010, China experienced an average GDP growth of 10.5%, fuelled by an extensive infrastructure expansion and real estate boom, financed through massive debt, leading to a "supercycle" of commodities. Meanwhile, developed markets lagged after facing the Dotcom (2001) and Lehman Brothers (2008) crises. Following these impacts, the consensus view was clear: emerging markets were the future and were ready to outperform developed markets. However, the majority opinion could not have been more wrong: since 2010, this region has underperformed the global market significantly (50% vs. 287%).
Market Return MSCI Emerging: 2001-2024
The factors explaining this behaviour are multiple, but we would highlight:
1.?????? The strength of the dollar over the last decade, which has reduced the export competitiveness of these countries.
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2.?????? The increase in geopolitical tensions, with conflicts between China and the United States and Russia's invasion of Ukraine as the main examples.
3.?????? The slowdown of globalization and recent reshoring dynamics (where companies try to diversify their supply chains away from Asia).
4.?????? Issues with the real estate and financial sectors in China.
All these issues have negatively affected the sentiment and perception of these countries. However, the valuation gap between developed and emerging markets is becoming increasingly attractive and difficult to ignore. The recent years have been dreadful for investors in the region, where market consensus views them with disillusionment, to the extent of considering some regions like China "uninventable" We consider this view overly pessimistic and would like to remind that the future belongs to them. They have the demographics, growth, and increasingly dynamic and technological economies. Gradually, the centre of global power is shifting towards their sphere of influence, and they have ceased to be mere exporters of cheap products to match and in some cases surpass their Western counterparts. At the same time, they have transitioned from being mere exporters to consumers, with obvious implications for local businesses.
PER forward 12 months: Discount/premium for emerging vs. developed markets
This divergence between investment styles, especially between the value and growth segments, is particularly interesting in the context of emerging markets. While the value segment has been mistreated by investors, even more so than in the West, it has generated an even more attractive discount compared to the growth segment. This situation has created valuable opportunities for investors seeking value in these markets.
Over the past decade, investing in emerging markets may have resulted in lower returns compared to global stock markets. However, investing in the value segment of these markets may have meant even lower returns. It is noteworthy that today, companies with profits trading at a market capitalization lower than their net cash position can be found, underscoring the level of discount these companies have been subjected to.
This divergence between investment styles and the opportunities offered by the value segment in emerging markets could be attractive for investors with a long-term perspective and appropriate risk tolerance.
Partially, the decline in valuations of this segment is justified by the cooling of the Chinese economy and the dimmer prospects regarding globalization. Since the pandemic, many companies have become aware of the need to diversify their production chains away from China. However, from Alkimia's perspective, we observe how the market overlooks the fact that this dynamic greatly benefits other countries in this region such as India, Vietnam, or Thailand.
China: Valuations Near Historic Lows
In conclusion, we find it hard to believe that emerging markets could fare worse than developed ones in the next decade, and therefore, we consider it necessary to structurally overweight equities from this region in portfolios. This will entail maintaining a contrarian view to the current consensus. However, patience is required here, understanding that extraordinary stock returns are not built by looking at past performance, but rather towards the future. The importance of these countries in the global economy will only increase.