This article was stimulated by interesting comments about overbought and oversold foreign markets by Birinyi Associates (Ticker Sense) , and by emerging market closed-end fund premium/discount comments by Herb Greenberg (Market Watch). Both suggested things are getting pretty “toppy” internationally.
They may be right, particularly the short-term, but I am wondering if the opposite might be coming about. This is not a prediction, but rather a questioning.
So, what is in store – a terrible correction or a ride to the moon? Here are two interesting charts to wrap your mind around before you place your own bet. Whichever way it goes, our only solid prediction is that it will be fairly dramatic.
First, here is a 15 year chart of the premium/discount for both of the closed-end funds Herb Greenberg talked about - the Morgan Stanley Emerging Markets Fund (NYSE:MSF) and the Credit Suisse Emerging Markets Telecom Fund (ETF) [the symbol is ETF, but it is not an ETF it’s a CEF]:
The current discounts for MSF and ETF are currently negative 6.1% and negative 3.7% which compares to month-end averages since inception (15 years for MSF and 14 ½ years for ETF) of negative 8.9% and negative 12.5%. ETF has not seen so little discount since 1996, although MSF has seen this much discount in 2003, 2004 and 2005.
That would suggest “toppyness” in the emerging markets telecom sector and maybe not so much in the general emerging markets sector. Since telecom is a big part of emerging markets, if it were possible to extract the telecom sector, the remaining emerging markets discount would enlarge significantly, we would think.
On the other hand, for both the general emerging markets and the emerging telecom sector, the current narrowing of the discount could foretell a return to earlier times when substantial premiums were the rule.
Those two CEFs sported big premiums in the first half of the 1990’s (also war years), but were displaced as favorites by the internet centric sectors mid-decade. Remember that the internet took off in 1994 when online imagery became practical and the internet moved beyond text and the academic sphere into the eye-candy and online commerce sphere. Then the emerging markets took a hit in the 1998 time frame probably related to the currency crisis that rocked markets back then.
Note how as the internet fad crumbled around 2000, the discount for emerging markets began to shrink right through 9/11 to today. What if the premium of the early nineties was the natural condition for small, illiquid, difficult to access and rapidly growing markets? If that is the case, then perhaps there is a lot more UP to go – or maybe not. We are as nervous as the next guy about a big correction, because we hold emerging market stocks, but we tend to think that longer-term there’s a lot of UP left.
You can see from the chart below how more gains might be in the cards.
Over the past 15 years (actually 14 years 11 months through November 30th), the MSCI Emerging Market Index has not done too much better than 10-year US Treasuries, even after some very strong recent returns. The cumulative index is way below the return for the Russell 3000 broad US stock index over the same 15 years.
If you are the mind that emerging markets “should” have performed better relative to the Russell 3000 than they did, in combination with the above discussion of the CEF closed-end premium discount over the past 15 years, you might argue that there is plenty of UP left in the catching-up process. Or, maybe not. We’d like to hear from readers about how to interpret the data.
Disclosure: Author owns EEM