Vladimir Putin, Russia’s sabre-rattling president, has played an amazing hand over the past year. Having buffed his domestic image at the Winter Olympics in Sochi, he subsequently annexed the Crimean peninsula and is effectively taking steps toward creating a puppet state within Ukraine.
The redrawing of the Eastern European map is a significant source of worry for investors in emerging markets. Longer-standing concerns include the deceleration of both Chinese economic growth and the recent end to the US Federal Reserve’s quantitative easing (QE) program (the unconventional purchasing of government bonds), which has heightened the possibility of an interest rate hike on the horizon.
The investment industry’s penchant for catchy slogans – recent examples being “BRICS” for Brazil, Russia, India, China and South Africa and the “Fragile Five” for Turkey, Brazil, India, South Africa and Indonesia – may cause some investors to treat wide swaths of the global economy and financial markets as interchangeable. In our view, such treatment is a mistake.
If the tendency of news media and investors to lump countries together causes their economies and markets to behave more like one another, investors who obtain their emerging markets exposure through index-tracking exchange-traded funds (ETFs) may suffer the most. That’s because, if correlations rise, the potential benefit of diversification would decline. In contrast, we believe those who invest in carefully researched companies that happen to be located in emerging markets may be less affected, particularly if they are long-term investors.
Equity valuations are – or should be – another concern for investors. European and US share prices have more than doubled over the last five years, leaving valuations in those regions pretty full. As such, valuation risk should be one of an investor’s primary concerns.
We recognise two main ways that long-term stock investors can lose money: buying companies that go bust or paying too much. The latter represents valuation risk.
Thinking “long term” gives you comfort
Policymakers at the European Central Bank (ECB) have observed the troubles caused by deflation – the six years it took Hong Kong to end the cycle of falling prices it experienced after the Asian financial crisis in 1998 and the multi-decade stagnation of the Japanese economy – and are keen to avert such a fate for Europe.
Whether economic growth in any given region surpasses or lags expectations, however, may not matter as much as some may think. That’s because it’s our belief the relationship between economic growth and stock market performance is weak. It helps to have a long-term perspective. Our firm could be seen as “the crocodile beside the river that needs to eat only three or four times a year.” Infrequent “dining,” in this case, refers to our preference for a low-turnover approach to portfolio management.
Even in times of market turmoil, we have comfort because we take a long-term view and we know our companies well.
There’s always shampoo
A good example is a British chemical company we hold in our portfolios that makes specialty chemicals that serve as a key ingredient in shampoos and scores of other products. It has survived depressions and world wars and many lesser trials. This company’s chemicals are a minor ingredient in shampoos, but all that hair-washing adds up.
All that hair-washing adds up.
For example, Brazilian ladies tend to wash their hair twice a day.1
So, as investors we must cut through all the market noise and look directly at our individual holdings to try to measure how we will perform in down or sideways markets. We look at the management of the companies, the balance sheet strength and any trends in the industry. We then ask ourselves something as simple as “Are Brazilian ladies going to stop washing their hair because of the crisis in Ukraine?” The answer, reassuringly, is usually “Probably not.”
1It may be an exaggeration to say that “Brazilian ladies wash their hair twice a day,” but research published in 2010 by Euro monitor International Ltd., a London-based market researcher, identified the Brazilian cosmetics market as one of the fastest- growing on the planet, with compounded annual sales growth of 14% between 2003 and 2008. “Brazil has more Avon Ladies (900,000) than soldiers in its army and navy put together,” according to a 2013 paper by professors at the Maria Curie-Sklodowska University in Poland (“Global Beauty Industry Trends in the 21st Century”).