Ceteris Paribus? Not!
JAMIE VICECONTE
CHIEF MARKETING OFFICER
CO-CHIEF INVESTING OFFICER
2 min read
Looking at the performance of an overall portfolio, we analyze the holdings in the portfolio to understand what drives returns. Varying forces can explain return differentials across geographies, some at times expected and some not.
This year, expectations for economic recovery by geography have changed as the effects of the Delta variant have become more apparent in specific countries. The rebound in commodities as global demand/supply imbalances developed has been one of the positive surprises to counter those Delta effects in specific Emerging Market (“EM”) countries. Lastly, political forces, specifically in China and its government’s pronouncement and actions on some Chinese companies internally and on western investment in Chinese companies in general, seemed to come out of the left field – but in hindsight really didn’t.
So, counter to the caveat “ceteris paribus,” all else has not been equal around the globe. Broadly, while the US Equity markets are up 17.0% year-to-date (“YTD”), International Developed and EM Equities are up 11.2% and 2.0%, respectively. The many EM countries’ Equity markets that benefited from the surge in commodity prices were virtually all dragged down by Delta variant fears as the year has progressed.
In terms of political effects on markets, the Chinese Communist Party’s (“CCP’s”) initiatives last month were the culmination of the deteriorating relations between the US and Chinese governments that have carried over into the Biden administration. Some of the largest Chinese tech names, e.g., Alibaba and Tencent, which make up almost 25% of the Chinese market indices, were already under pressure based on the CCP’s attempts to reign in some of those companies’ growth plans in domestic financial services. These actions held the Chinese EM index allocation to a 1% gain YTD through June 30th. The pronouncement of potential restrictions of US listings, starting with an investigation into Didi Chuxing, a Chinese ride-hailing app, just days after its New York IPO debut, wound up pushing Chinese equities down over 13.5% in July. As China makes up over 37% of the EM index, these actions and their contagion effects significantly impacted overall EM returns for July.
Does this mean we are supposed to reduce exposure to China or EM in general? Not necessarily. There has been much handwringing of late on EM exposure in portfolios in general and how much investors should have. Recent past performance would suggest reduced exposures. But current valuations and the continued potential for above-average global growth in the largest countries in the index, specifically China, South Korea, Taiwan, and India, which make up almost 75% of its holdings, argue for at least a market capitalization-weighted exposure.
We have done a lot of handwringing on this ourselves, but we have also read a lot of the research, listened to the webinars and podcasts, and done some of our own homework. Our conclusion: we don’t think it’s time to throw in the towel. We need to remember that trends will go on for as long as they can, until they can’t, to paraphrase the economist Ben Stein. The trend for US outperformance has been going strong for ten years and valuations versus non-US markets and Growth over Value Equities are still at or close to historical extremes. All metrics point to staying geographically diversified along with a tilt towards value for the longer term.
Our equity allocations were down roughly 0.48% on the month versus the MSCI ACWI benchmark’s 0.66% return. That leaves us lagging the benchmark by approximately 1.34% YTD. In our Fixed Income allocations, accounts were down 0.3%, lagging the Bloomberg Barclays AGG benchmark, which was up 1.12% for July. That still leaves our Fixed Income allocations up 3.13% YTD versus the benchmark’s -0.54% return.
