The two biggest economies in the world could hardly look more different at the moment. One is doing all it can to stimulate growth, while the other is trying to rein it in.
In the US, the Obama administration is ploughing a lonely furrow, the only major country in the world to be easing fiscal policy this year.
On the other side of the world, China faces a completely different set of problems. Its economy grew by 9.7% in the first three months of the year, only a fraction slower than the 9.8% in the last quarter of 2010. Chinese inflation, at 5.4%, is higher than it has been in nearly three years.
For the first time, the Chinese government has indicated that it will allow its currency to appreciate against the dollar in a bid to increase the country’s purchasing power in international markets and prevent prices from spiralling out of control. In the meantime, it has imposed price curbs from home appliances to food and pharmaceuticals.
Against these very different economic backcloths, it is unsurprising that investors remain undecided about whether to back the emerging or developed market horses this year.
In the short-term the conditions for US equities look more favourable than they do in the key developing markets with monetary policy deliberately behind the curve of an increasingly healthy economy.
Longer-term, investors in search of sustainable economic growth remain much more likely to find it east and south of Suez than in the debt-burdened old world. Even if, as expected, China’s growth rate pulls back to a less super-charged 5-6% a year in the medium term, the rest of us will look on enviously.
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Over the last 17 or so years since data has been compiled for the emerging markets and comparisons with the US’s S&P 500 have been possible, the two have marched to completely different drumbeats but ended up in the same place.
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During the 1990s when the US was developing an infatuation with technology, media and telecoms, the developing world was in crisis and its equity markets in aggregate did nothing for 10 years. Then while the US endured its own “lost decade” emerging markets took off. During the financial crisis, the two have moved more or less in lock step.
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What lessons can be drawn from this and what does it mean for anyone trying to decide where to put their money today? The key point is that valuations matter. When emerging markets started their massive outperformance of the developed world in 2003 their shares were on average about half as expensive (in price to book value terms). At the top of the market in 2007 they stood at a 20% premium on the same basis. Developed market shares underperformed from 2000 because they started out at a silly price.
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Fast forward to today and there’s not a lot to choose between the two in terms of valuation. Emerging market shares are priced at about twice the value of their underlying assets while the world as a whole is at 1.9 times.
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If picking winners over a 20 year timeframe is impossible, and anyway might end up in a dead heat, the only sensible thing may be to make sure you have a bit of everything.
