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Do You See What I See?
Last night, my 4-year-old regaled me with holiday songs including the classic Do You Hear What I Hear? It reminded me of the disconnect between what we look at as professional investors and what non-professionals will ask or comment about. A great recent example is something that has been making headlines: oil prices. While it seems like only yesterday the discussion was around ‘peak oil’ and prices heading to $200 a barrel (which was an actual forecast by the esteemed Goldman Sachs when oil was $140 a barrel – it promptly dove to $35 a barrel during the Great Recession), today much of the talk is around permanently low oil prices. But that is all rearview mirror investing, or better yet speculating.
Here is something to consider regarding the top three components of XLE, an Exchange Traded Fund holding many of the largest integrated oil and service companies in the world. The last ten year period witnessed nearly a 75% drop in oil, however the top holdings within XLE did the following:
As with any industry, there are the winners and the losers when some type of major disruption occurs. By being well diversified and owning the best of breed companies that have long histories of profitability and preferably an increasing dividend over time, you can rest well knowing that your holdings will not only survive whatever near-term challenges the market poses, but in many cases come out the other side stronger. Remember, these are not unprofitable internet companies like those bid to preposterous valuations during the internet bubble. So the next time you see the price of oil or some commentator gyrating wildly, think about a company like XOM that has been sending checks to shareholders for over 130 years and that will put the near-term oil price volatility into proper perspective.
Is There Any One Out There?
Lately it has seemed like there is no reason to invest in stocks outside the U.S., as domestic equities have materially out-performed most foreign markets, especially emerging markets. But the five most dangerous words in investing are, “…it is different this time….” These words were spoken in the late 1990s when many investors declared there is no reason to put a penny into any company that does not end in dot-com. Similarly in the mid-2000s, the thinking was the only investment anyone needed was a nice piece of real estate since prices couldn’t possibly ever go down again. We all know how those movies ended.
While near term absolute and relative performance has been weak for emerging markets, as with analyzing oil stocks, one must take a step back from the day-to-day dire headlines and look at the bigger and longer picture. Since 2003, emerging markets, as measured by the ETF EEM, have returned nearly 13% per year on average versus around 9% for US stocks (as defined by SPY). This may seem like a small difference, but over that time period it translates into nearly 150% greater gains for emerging markets. Certain asset classes have strong propensities to outperform others over time (e.g. stocks tend to outperform bonds, albeit with greater volatility), certain market caps tend to outperform others (faster growing small caps tend to have better returns than large caps over long periods), and economies with higher growth rates like those found in EEM tend to offer higher returns over long periods versus developed markets, again with the commensurate greater ups and downs along the way.
But we find ourselves in an unusual situation today whereby faster growing EEM is actually trading at a large discount to SPY, the former’s P/E being around 12X versus the latter’s 18X depending on how you calculate the ratio using recent earnings, projected earnings, etc. But no matter how you look at it, emerging markets are cheap on an absolute and relative basis, and domestic stocks are at the other end of the valuation spectrum. Of course the same could have been said a year ago, proving the point that you can never call a top or a bottom to a market… except after the fact. Thus, the recent trend could easily persist for longer than the numbers suggest it should. But if you are looking out over the next ten years, considering what transpired over the last ten years, a very compelling argument can be made to have some allocation to emerging markets as a means to diversify away from, and outperform, domestic equities that have not seen a 20%+ correction in nearly seven years and that are trading above their historical P/E average.
Scott Kyle, CEO/Chief Investment Officer