Question: When is an emerging market stock not really an
emerging market stock?
Answer: When the company sells virtually all of its products in
In the decades that followed World War II, Japan pioneered the
of economic development, which can be boiled down to two bullet
This was a wildly successful strategy-so long as the Westerners
were buying. Following Japan, it is what allowed Taiwan and South
Korea to enjoy European levels of development and China to quickly
jump from being one of the poorest countries in the world to be the
number two economy after the United States.
But with consumer demand in the West tepid at best (see Figure
1), this model is looking questionable. China managed to post an
8.7% annual growth rate in 2009, and a blistering 10.9% in the
second quarter of 2010.
This would normally be considered phenomenal. But
92% of the 2009 number was capital spending
, a fair amount of which was spurred by government stimulus
programs. If you take out capital spending investment, China's
economy barely budged at all.
click to enlarge
China is a unique case. Not all emerging economies are as
heavily driven by infrastructure and construction spending. But the
problem is that
most emerging market investment options for retail
investors are weighted specifically to these sectors that I see as
being the most at risk: financials, construction, and manufactured
Enter the Emerging Market Consumer
While I question the sustainability of the "Asian Model" of
I am not at all bearish on emerging markets in
The rise of the Emerging Market Consumer is real, if
is any indication. In Figure 2 we can see that Indian and Brazilian
consumers barely missed a beat during the crisis. Consumer spending
continues to soar higher.
So, how do we as passive portfolio investors profit from these
Sizemore Investment Letter
, we have thus far chosen to invest mostly indirectly, buying
Western firms like
Philip Morris International (
that have a strong presence in emerging markets. Our only direct
investment thus far has been in
, the leading mobile communications company in Turkey.
The standard answer for most investors, however, has been to buy
an emerging market mutual fund or ETF like the popular iShares MSCI
Emerging Market Index Fund (
The problem is that this ETF is perhaps the most poorly named
ETF in history. It's not a play on emerging markets at all. It is
primary an indirect play on the
consumer, as most of its constituent parts are export-oriented
companies, materials companies, and banks.
Take a look at Figure 3, which lists EEM's largest holdings.
Samsung (SSNLF.PK) and Taiwan Semiconductor (
) top the list, followed by a string of banks and oil companies.
This is hardly a play on the emerging market consumer. What's more,
consider the country concentrations in Figure 4.
China and Brazil have the largest concentration, which is fine.
But following Brazil, South Korea and Taiwan make up a combined 24%
of the fund. Nothing against these countries, of course, but it's
hard to really consider them "emerging markets" today. If Greece
and Portugal are considered "developed countries," then why are
South Korea and Taiwan not? (MSCI considers certain factors such as
the convertibility of the local currency as criteria. Still, my
Up until very recently, Israel also had a fair-sized allocation
in the fund. It's hard to see what Israel-which is second only to
Silicon Valley in tech startups-was doing in an index full of South
American and Pacific Rim developing countries.
It should be obvious that when you buy EEM, you're not really
buying an emerging market fund. You're buying a volatile
market fund with high exposure to global factors-i.e. the American
consumer, international banking, and commodities prices (see Figure
5)-and virtually no exposure to the real source of long-term
growth, the Emerging Market Consumer. Less than a fourth of EEM's
holdings are in consumer oriented sectors, such as consumer goods
and services, utilities, and telecom.
Of course, you could always assemble your own portfolio of
emerging market consumer stocks and American companies with growth
prospects abroad-stocks like
recommendations Philip Morris International, Turkcell, and
Telefónica. But some investors prefer a "one-stop shop" for the
Emerging Market Consumer. I finally have a good one to
Introducing the Dow Jones Emerging Markets Consumer
Titans Index Fund
Emerging Global Shares has stepped up and filled a gap that
sorely needed to be filled. The company has launched a series of
emerging market sector funds-including, among others, basic
materials, metals and mining, financials, health care, industrials,
technology, telecom, and utilities.
For now, some of these sectors do not fit my portfolio strategy;
my focus is capitalizing on the growth of the Emerging Market
Consumer. Emerging market metals and mining, for example, is not
likely to ever have a place in the portfolios I manage.
The new EG Shares DJ Emerging Markets Consumer Titans Index Fund
) begins trading on Tuesday September 14 and is
the fund I've been waiting for. Let's take a look at what's under
In Figure 6, we see a very different mix of companies than in
EEM's Figure 3. The largest holding is Brazilian mega-brewer AmBev,
which is a perfect match for the
on multiple counts. Not only is it an excellent play on the rise of
South America's middle class, it is also a "sin stock" that I
consider attractive. (See "
Why Good Investors Like Bad Stocks
We also see a much different country allocation, as you can see
in Figure 7.
Brazil and Mexico are the largest concentrations. Conspicuously
absent are South Korea, Taiwan, and Israel-countries that, whatever
their investment merits, have no place in an emerging markets
portfolio. Also, China is a comparatively small allocation. Given
my ambivalent view of China and its apparent real estate and
infrastructure bubbles, that is fine by me. Any investor wanting to
complement ECON with more direct exposure to China's consumers can
add a small allocation to The Global X China Consumer ETF (
), which I covered in a
All of this sounds great on paper. It is a story that makes a
lot of sense as an investment theme. But how does it actually
ECON is a new ETF and has no history. But the index on which the
ETF is based goes back to December 30, 2005, making it possible for
us to make comparisons. Figure 8 compares ECON to EEM and the
Over this time period, several observations can be made. All
three indexes rose during the global bull market, fell during the
crisis, and rose again during the recovery. Correlations were
particularly tight during the meltdown and subsequent "melt-up."
EEM led the back before the meltdown, which should be expected
during a prolonged global boom. ECON has performed the best since
the March 2009 bottom, however, and now comfortably sits near new
During a global boom, I might expect EEM to perform better than
ECON, as it is driven more by global factors and is comprised of
more cyclical companies. But in a period of "decoupling" in which
growth is comparatively slow in the West, I would expect ECON to
Remember, our goal here is not necessarily to generate the
highest return in any given period (though this would clearly be
welcome). This is not a "high beta" trade. Our goal is to get
targeted exposure to a powerful demographic macro trend-the rise of
the Emerging Market Consumer.
In this age of globalization, virtually all markets are
correlated to some extent. It's nearly impossible to find growth
without accepting some amount of global beta risk. That said, ECON
keeps its beta risk to a tolerable minimum. Let's prove this
In Figure 9, I built a matrix that compares the correlations
between the daily returns of the three indexes from Figure 8.
For those who might be a little rusty on their statistics, the
correlation coefficient is the degree to which two assets move
together. A value of 1 is perfect correlation, meaning that the two
assets move in lock step. A value of -1 is perfect negative
correlation, meaning that two assets move opposite of one another
(for example, and long and short position in the same security
would have a correlation of -1).
Figure 9 confirms everything I wrote earlier in the article. The
correlation between the S&P 500 and EEM is .895-not quite
perfect correlation, but awfully close. This tells us statistically
what we already knew-that EEM is not really an emerging market play
at all, but rather a higher-volatility play on the U.S. consumer.
Interestingly, the correlation between the Emerging Market Consumer
Index and the S&P 500 is only .669.
The numbers get even more interesting when we divide the data
into sub-periods. It is common knowledge among traders that "all
correlations converge to 1" during a financial crisis. This
certainly held true during the meltdown that followed the collapse
of Lehman Brothers in 2008. All assets save U.S. Treasury bonds and
the U.S. dollar fell in unison during that unfortunate period, and
it was scary to live through.
Figure 10 isolates the crisis months, defined here as July 2008
through March 2009. Correlations didn't quite converge to 1, but
they came pretty close. The correlation between the S&P 500 and
EEM rose to 0.916, and the correlation between the Emerging Market
Consumer Index and the S&P 500 jumped to 0.732. During this
nightmarish series of months, there was really nowhere to hide.
This raises an important point: given the extreme nature of the
2008 meltdown-the biggest of its kind since the 1907 panic-are the
tight correlations of that period distorting the "normal"
correlations that we would see under more benign circumstances?
Let's take a look.
Figure 11 is a correlation matrix that excludes the volatile
July 2008 to March 2009 time period. Just as I suspected,
correlations in Figure 11 are lower across the board than those in
the original Figure 9.
The correlation between the S&P 500 and EEM is still
unacceptably high at 0.862, but the correlation between ECON and
the S&P 500 is significantly lower at 0.605.
By this point, I've probably overloaded you with statistical
jargon. Don't worry, we're done with it for now.
In case you glazed over after the first mention of the word
"correlation," these are the relevant points to take away:
EEM is an ineffective way to get exposure to emerging
markets; it's really a play on the American consumer-which we
distinctly want to avoid.
ECON provides a better alternative-direct exposure to the
emerging market consumer.
The rise of the emerging market consumer is
demographic growth theme for the decades ahead.
Action to take: Buy shares of ECON for the portion of your
portfolio allocated to emerging markets. Make this a core portfolio
PM, TKC, TEF, and ECON are recommendations of the Sizemore
As Coal Heats Up, 3 Companies With Persuasive Coal