Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

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Topic Author
Nicolas Perrault
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Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 2:46 pm

Most investment books suggest an allocation to Emerging Markets, usually between 5 and 10%. The reasoning usually goes that they offer useful diversification. My main issue with emerging markets is that I suspect the market evaluates their value with two-inch thick rosy glasses in a fog so thick one couldn't see the end of one's nose.

Even the "emerging" in "emerging markets" assumes that these countries are going somewhere, whereas (who knows) they might not be going anywhere at all. In the mid-1820s, in England, Latin American bonds were all the craze. They've just broken free from the Spanish! The world is theirs! Two hundred years later, these countries have not yet emerged and one wonders whether they ever will. Perhaps the markets of countries where the institutions were solid enough and the people honest enough to allow fruitful investing all have already emerged. I have serious doubts that any of the remaining markets will do so in the next century. The institutional and cultural backbone might just not be there.

I just finished the final edition of the Intelligent Investor by Benjamin Graham (with comments by Jason Zweig). What I found most informative was the extent to which American companies can and do trick the numbers in their reports to make analysts believe that the company's earnings are growing faster than they actually are. According to Burton Malkiel this is called "creative accounting" or "financial engineering". He prefers the phrase "financial alchemy" (A Random Walk Down Wall Street, 2015 edition). Companies may report "pro forma" earnings (i.e. earnings without all the bad stuff). They may report as one-time revenue this year the revenue of years to come. They may cram into last year's report all the bad stuff of years to come. They may fudge the numbers outright. The possibilities for being dishonest in the annual earnings report are infinite, especially, presumably, in countries where the local Securities and Exchange Commission is underpowered or corrupt.

I had the chance to visit Fiji about ten years ago. In a supermarket, I grabbed a box of Frosted Flakes, even though the price of the item was nowhere to be found on the box or on the shelf. It went at the cash register for 12 dollars and the store would not accept a return. I swore never again to buy anything without knowing the price. The question now is, is it possible to know the price of 1$ of annual earnings in an emerging market? Yes, if you can trust the reports of companies to figure out how much the companies are actually earning. But can you?

The value of a stock is largely determined by its present earnings and its expected earnings growth in the future (although the worth of these expectations are seriously questionable, even when the numbers in the report can be trusted). How is the market to efficiently value emerging market stocks if the earnings report of the relevant companies can't be trusted? I'm not sure it can. And if the stocks can't be valued properly, why are people buying them in an index fund or otherwise?

Am I claiming I know something that the market doesn't? Certainly not, but in terms of emerging markets --- in a way that would parallel cryptocurrency --- I wonder whether the market knows enough to estimate the worth of emerging market stocks to the closest order of magnitude.

Here's an excerpt of a 2015 Morningstar interview of William Bernstein (https://www.morningstar.com/videos/7183 ... today.html):
-Interviewer: [L]et's talk about emerging-markets equities. [...] Are they good and cheap today?
-Bill Bernstein: They are cheap; they are not good and cheap.

This is brilliant, classic Bernstein. But Bill, I'm wondering, how do we even know they're cheap? To say they're cheap, you've got to believe the numbers in the earnings report of companies in countries ranking poorly in the corruption perception index. But should you?

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by mtn biker » Sat Jan 12, 2019 3:14 pm

I think the reason they are "cheap" right now is exactly because of all you said. The possibility that it is actually cheap and not just cheap on paper is a reason to buy. The possibility not enough of those markets will show growth is a reason to avoid a large percentage of your assets in the area.

All emerging markets do not have to do well in order for a good return, just like all investments by venture capitalists do not do well, matter of fact, most do poorly. But there is the decent chance that a small percent will do phenomenally well, which can more than offset the underperformance of the bulk. You didn't need to just buy FANG stock 10 years ago to beat the full index, if you bought all technology stocks you still beat the full index. More importantly, if you had avoided tech stocks 10 years ago you would have greatly underperformed. Same thing here. Over 10 years maybe EM will perform greatly, maybe not, but unless it's part of your portfolio you cannot benefit, and to avoid it is to actively bet against it. I don't claim to know whether EM is cheap or not, but by owning a piece I am keeping my position more neutral, as apposed to betting for or against.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by stan1 » Sat Jan 12, 2019 3:22 pm

Common argument against international for many years. Some people don't care. Some people use it to justify holding no international stock. Others use it to justify something in the middle (about 20%).

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by KyleAAA » Sat Jan 12, 2019 3:23 pm

In general, the market is intelligent enough to account for fraud and bake it into valuations. There are exceptions, of course, but even in prominent cases like Enron it was known there was fraud taking place by forensic accountants at least a year or two prior to the collapse. Why the market didn’t price in that information, I don’t know. Or maybe it did. There is also FAR more data to go on these days than even 15 years ago. The market is good at what it does. The actual effectiveness of creative accounting in fooling the market these days is quite low.

drk
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by drk » Sat Jan 12, 2019 3:32 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Am I claiming I know something that the market doesn't? Certainly not
Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, of course, but you may want to avoid introducing cognitive dissonance.
Last edited by drk on Sat Jan 12, 2019 5:20 pm, edited 1 time in total.

sambb
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by sambb » Sat Jan 12, 2019 3:50 pm

Enron happened in the USA. GE his happening now here with regards to valuation. Buyer beware in the s and p 500 of the USA also.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by nisiprius » Sat Jan 12, 2019 4:01 pm

I would make two points.

First, "fairly valued" is not an assumption behind an important argument for cap-weighted indexing. The theory is outlined here and has to do with characteristics of the market portfolio (all of the assets held within a market). It has a number of assumptions, but "fair valuation" is not among them. (The chief assumption is that we are dealing with rational participants within a single market within which assets trade freely and frictionlessly, which is not the case for the set of global stock markets, and not the case when more than one currency is involved). But you do not have to assume fair valuation to have a rationale for cap-weighting.

Second, prove that it makes much difference either way. I don't think it does. Flip a coin, follow your instincts, whatever, then stick to it. When people say it has made a lot of difference, it's generally because they are talking about how EM has done recently. But emerging markets are less than a tenth of the global total of the worlds' markets, and they have had an 0.92 correlation with international stocks in general, so how can it matter much--unless you decide to give them a huge overweight?

Here's an impressionistic idea of "how much it might have mattered" if you had put $100 a month into a portfolio of 30% US stocks, 30% international, and 40% bonds for twenty years. The difference is whether the international stock fund used was developed-only (green), or included emerging markets (red).

Part 1: Introduction, Appendix: Methodology
Brief notes: 1) In these Monte Carlo simulations, the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of outcomes. 5) The actual data source is PortfolioVisualizer.com, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.
The crosses and centerpoints are what they are. They are subject to all the issues and problems of comparing two portfolios over one specific period in time. They have exactly the same endpoint issues of all such comparisons. These charts do not help decide which portfolio is better than another, or how much better. Their purpose to compare the size of difference between portfolios to the general variability of the portfolio. They are based on Monte Carlo simulations of random walks around the historical data. The value of this approach has been questioned; see discussion

(Green)
VTSMX Vanguard Total Stock Mkt Idx Inv 30.00%
FSIIX Fidelity International Index Investor 30.00% (developed markets only)
VBMFX Vanguard Total Bond Market Index Inv 40.00%

(Red)
VTSMX Vanguard Total Stock Mkt Idx Inv 30.00%
VGTSX Vanguard Total Intl Stock Index Inv 30.00% (developed and emerging at cap weight)
VBMFX Vanguard Total Bond Market Index Inv 40.00%

Image
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.

Topic Author
Nicolas Perrault
Posts: 16
Joined: Thu Sep 27, 2018 12:33 pm

Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 4:40 pm

drk wrote:
Sat Jan 12, 2019 3:32 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Am I claiming I know something that the market doesn't? Certainly not
Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, or course, but you may want to avoid introducing cognitive dissonance.
Actually, I'm not assuming I know anything more than the market. I'm just not convinced I want to give emerging markets the benefit of the doubt, whereas the market partially does. In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet. Imagine a man had a coin that he was going to flip. The man allows the market to bet on the outcome "heads" only (not tails), and does not allow the market to inspect the coin to make sure it's not biased in favour of tails. The man assures the market that if the market loses the bet, he will only charge him half. Were both the coin and the man fair, the market would win twice as much on heads than he would lose on tails. Sure, the market may say "10 bucks on heads!", but unlike the market, I will abstain on the bet. The market gives the benefit of the doubt to the man with the coin, but I don't. Do I need to believe I know more than the market to make this decision? No I don't.
mtn biker wrote:
Sat Jan 12, 2019 3:14 pm
I think the reason they are "cheap" right now is exactly because of all you said. The possibility that it is actually cheap and not just cheap on paper is a reason to buy. The possibility not enough of those markets will show growth is a reason to avoid a large percentage of your assets in the area.

All emerging markets do not have to do well in order for a good return, just like all investments by venture capitalists do not do well, matter of fact, most do poorly. But there is the decent chance that a small percent will do phenomenally well, which can more than offset the underperformance of the bulk. You didn't need to just buy FANG stock 10 years ago to beat the full index, if you bought all technology stocks you still beat the full index. More importantly, if you had avoided tech stocks 10 years ago you would have greatly underperformed. Same thing here. Over 10 years maybe EM will perform greatly, maybe not, but unless it's part of your portfolio you cannot benefit, and to avoid it is to actively bet against it. I don't claim to know whether EM is cheap or not, but by owning a piece I am keeping my position more neutral, as apposed to betting for or against.
Fair point, I understand the view that "The possibility that it is actually cheap and not just cheap on paper is a reason to buy." and I respect it.

I don't think avoiding a market is actively betting against it in the same way that, for example, short-selling it would be. I would not accuse you of betting against Bitcoin if you refused to buy any bitcoin (especially if your grounds for refusing to buy bitcoin are that the world of Bitcoin is so obscure that you don't want your money to have anything to do with it). You would be betting against it if you short-sold it.
sambb wrote:
Sat Jan 12, 2019 3:50 pm
Enron happened in the USA. GE his happening now here with regards to valuation. Buyer beware in the s and p 500 of the USA also.
Absolutely. If it's happening in the USA, imagine how it must happen elsewhere in places where institutions are probably not as solid as in the USA.
KyleAAA wrote:
Sat Jan 12, 2019 3:23 pm
In general, the market is intelligent enough to account for fraud and bake it into valuations. There are exceptions, of course, but even in prominent cases like Enron it was known there was fraud taking place by forensic accountants at least a year or two prior to the collapse. Why the market didn’t price in that information, I don’t know. Or maybe it did. There is also FAR more data to go on these days than even 15 years ago. The market is good at what it does. The actual effectiveness of creative accounting in fooling the market these days is quite low.
Your last sentence does not surprise me, after all the SEC is doing a good job. Do you think that's the case in emerging markets too? Why or why not?
nisiprius wrote:
Sat Jan 12, 2019 4:01 pm
I would make two points.

First, "fairly valued" is not an assumption behind an important argument for cap-weighted indexing. The theory is outlined here and has to do with characteristics of the market portfolio (all of the assets held within a market). It has a number of assumptions, but "fair valuation" is not among them. (The chief assumption is that we are dealing with rational participants within a single market within which assets trade freely and frictionlessly, which is not the case for the set of global stock markets, and not the case when more than one currency is involved). But you do not have to assume fair valuation to have a rationale for cap-weighting.

Second, prove that it makes much difference either way. I don't think it does. Flip a coin, follow your instincts, whatever, then stick to it. When people say it has made a lot of difference, it's generally because they are talking about how EM has done recently. But emerging markets are less than a tenth of the global total of the worlds' markets, and they have had an 0.92 correlation with international stocks in general, so how can it matter much--unless you decide to give them a huge overweight?

Here's an impressionistic idea of "how much it might have mattered" if you had put $100 a month into a portfolio of 30% US stocks, 30% international, and 40% bonds for twenty years. The difference is whether the international stock fund used was developed-only (green), or included emerging markets (red).

Part 1: Introduction, Appendix: Methodology
Brief notes: 1) In these Monte Carlo simulations, the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of outcomes. 5) The actual data source is PortfolioVisualizer.com, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.
The crosses and centerpoints are what they are. They are subject to all the issues and problems of comparing two portfolios over one specific period in time. They have exactly the same endpoint issues of all such comparisons. These charts do not help decide which portfolio is better than another, or how much better. Their purpose to compare the size of difference between portfolios to the general variability of the portfolio. They are based on Monte Carlo simulations of random walks around the historical data. The value of this approach has been questioned; see discussion

(Green)
VTSMX Vanguard Total Stock Mkt Idx Inv 30.00%
FSIIX Fidelity International Index Investor 30.00% (developed markets only)
VBMFX Vanguard Total Bond Market Index Inv 40.00%

(Red)
VTSMX Vanguard Total Stock Mkt Idx Inv 30.00%
VGTSX Vanguard Total Intl Stock Index Inv 30.00% (developed and emerging at cap weight)
VBMFX Vanguard Total Bond Market Index Inv 40.00%

Image
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.

aristotelian
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by aristotelian » Sat Jan 12, 2019 4:46 pm

If you don't like EM, do not invest in EM. If there is a big boom in EM, you will miss out. That's the risk you take.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Dantes » Sat Jan 12, 2019 4:54 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.
South Sea Company was a single company, not a mutual fund.

Topic Author
Nicolas Perrault
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 5:01 pm

aristotelian wrote:
Sat Jan 12, 2019 4:46 pm
If you don't like EM, do not invest in EM. If there is a big boom in EM, you will miss out. That's the risk you take.
Fair enough. But I guess one could say the same of cryptocurrency, gold, and Rembrandt paintings. An investment is not automatically a good one just because there's a chance of a huge gain.
Dantes wrote:
Sat Jan 12, 2019 4:54 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.
South Sea Company was a single company, not a mutual fund.
That's right. What point are you trying to make? : )
Last edited by Nicolas Perrault on Sat Jan 12, 2019 5:07 pm, edited 1 time in total.

bluquark
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by bluquark » Sat Jan 12, 2019 5:02 pm

The concerns you're raising are in the category of "known unknowns". Everybody trying to price EM takes them into consideration. Some may mostly dismiss them, some may discount the price a great deal because of it.

Known unknowns always create a risk both on the upside and on the downside. So your argument hinges on your claim that there is an overall rose-colored view, and that therefore the risk is mostly to downside. But I don't see what supports that. On the contrary, I can formulate an argument that the bias is mostly bearish as follows: studies have shown investors, including institutional investors, have a strong home bias, and EM are the countries low on domestic investors, therefore they are the countries who wind up overall underinvested in due to home bias.

Secondly, you should actually look at the list of countries on the EM list. The real basket cases are in "frontier" -- the word "emerging" is bit dated and most of them are already rather developed and on reasonably stable footing today.
Last edited by bluquark on Sat Jan 12, 2019 5:06 pm, edited 2 times in total.

drk
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by drk » Sat Jan 12, 2019 5:05 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Actually, I'm not assuming I know anything more than the market. [...] In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet.
Here, I bolded the faulty assumption for you.

HalfMillionaire
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by HalfMillionaire » Sat Jan 12, 2019 5:08 pm

I don't think any people have a monopoly on being honest or having a cultural backbone (bolding by me in the excerpt below). It would come as a shock to China (world's largest economy by PPP) and India (3rd largest by PPP) that they have been lacking in honest people and cultural backbone.

The desire to have a better future is universal. Every society is trying to address their specific challenges and make life better for the coming generation. Some have more challenges than others - but making moral judgements and sweeping generalizations is uncalled for.
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Perhaps the markets of countries where the institutions were solid enough and the people honest enough to allow fruitful investing all have already emerged. I have serious doubts that any of the remaining markets will do so in the next century. The institutional and cultural backbone might just not be there.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by KyleAAA » Sat Jan 12, 2019 5:13 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
drk wrote:
Sat Jan 12, 2019 3:32 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Am I claiming I know something that the market doesn't? Certainly not
Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, or course, but you may want to avoid introducing cognitive dissonance.
Actually, I'm not assuming I know anything more than the market. I'm just not convinced I want to give emerging markets the benefit of the doubt, whereas the market partially does. In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet. Imagine a man had a coin that he was going to flip. The man allows the market to bet on the outcome "heads" only (not tails), and does not allow the market to inspect the coin to make sure it's not biased in favour of tails. The man assures the market that if the market loses the bet, he will only charge him half. Were both the coin and the man fair, the market would win twice as much on heads than he would lose on tails. Sure, the market may say "10 bucks on heads!", but unlike the market, I will abstain on the bet. The market gives the benefit of the doubt to the man with the coin, but I don't. Do I need to believe I know more than the market to make this decision? No I don't.
mtn biker wrote:
Sat Jan 12, 2019 3:14 pm
I think the reason they are "cheap" right now is exactly because of all you said. The possibility that it is actually cheap and not just cheap on paper is a reason to buy. The possibility not enough of those markets will show growth is a reason to avoid a large percentage of your assets in the area.

All emerging markets do not have to do well in order for a good return, just like all investments by venture capitalists do not do well, matter of fact, most do poorly. But there is the decent chance that a small percent will do phenomenally well, which can more than offset the underperformance of the bulk. You didn't need to just buy FANG stock 10 years ago to beat the full index, if you bought all technology stocks you still beat the full index. More importantly, if you had avoided tech stocks 10 years ago you would have greatly underperformed. Same thing here. Over 10 years maybe EM will perform greatly, maybe not, but unless it's part of your portfolio you cannot benefit, and to avoid it is to actively bet against it. I don't claim to know whether EM is cheap or not, but by owning a piece I am keeping my position more neutral, as apposed to betting for or against.
Fair point, I understand the view that "The possibility that it is actually cheap and not just cheap on paper is a reason to buy." and I respect it.

I don't think avoiding a market is actively betting against it in the same way that, for example, short-selling it would be. I would not accuse you of betting against Bitcoin if you refused to buy any bitcoin (especially if your grounds for refusing to buy bitcoin are that the world of Bitcoin is so obscure that you don't want your money to have anything to do with it). You would be betting against it if you short-sold it.
sambb wrote:
Sat Jan 12, 2019 3:50 pm
Enron happened in the USA. GE his happening now here with regards to valuation. Buyer beware in the s and p 500 of the USA also.
Absolutely. If it's happening in the USA, imagine how it must happen elsewhere in places where institutions are probably not as solid as in the USA.
KyleAAA wrote:
Sat Jan 12, 2019 3:23 pm
In general, the market is intelligent enough to account for fraud and bake it into valuations. There are exceptions, of course, but even in prominent cases like Enron it was known there was fraud taking place by forensic accountants at least a year or two prior to the collapse. Why the market didn’t price in that information, I don’t know. Or maybe it did. There is also FAR more data to go on these days than even 15 years ago. The market is good at what it does. The actual effectiveness of creative accounting in fooling the market these days is quite low.
Your last sentence does not surprise me, after all the SEC is doing a good job. Do you think that's the case in emerging markets too? Why or why not?
nisiprius wrote:
Sat Jan 12, 2019 4:01 pm
I would make two points.

First, "fairly valued" is not an assumption behind an important argument for cap-weighted indexing. The theory is outlined here and has to do with characteristics of the market portfolio (all of the assets held within a market). It has a number of assumptions, but "fair valuation" is not among them. (The chief assumption is that we are dealing with rational participants within a single market within which assets trade freely and frictionlessly, which is not the case for the set of global stock markets, and not the case when more than one currency is involved). But you do not have to assume fair valuation to have a rationale for cap-weighting.

Second, prove that it makes much difference either way. I don't think it does. Flip a coin, follow your instincts, whatever, then stick to it. When people say it has made a lot of difference, it's generally because they are talking about how EM has done recently. But emerging markets are less than a tenth of the global total of the worlds' markets, and they have had an 0.92 correlation with international stocks in general, so how can it matter much--unless you decide to give them a huge overweight?

Here's an impressionistic idea of "how much it might have mattered" if you had put $100 a month into a portfolio of 30% US stocks, 30% international, and 40% bonds for twenty years. The difference is whether the international stock fund used was developed-only (green), or included emerging markets (red).

Part 1: Introduction, Appendix: Methodology
Brief notes: 1) In these Monte Carlo simulations, the return for a given month is varied by randomly choosing the actual historical return or the actual historic return for an adjacent month. 2) They show the final value from $100 monthly contributions made over the whole time period. 4) Green and red crosses mark actual historical values. 5) Green and red bars show the 10% percentile, median, and 90% percentile of the range of outcomes. 5) The actual data source is PortfolioVisualizer.com, Backtest Portfolio, Monthly Returns; this is used as calculation input; and no PV content or numeric values are directly reproduced.
The crosses and centerpoints are what they are. They are subject to all the issues and problems of comparing two portfolios over one specific period in time. They have exactly the same endpoint issues of all such comparisons. These charts do not help decide which portfolio is better than another, or how much better. Their purpose to compare the size of difference between portfolios to the general variability of the portfolio. They are based on Monte Carlo simulations of random walks around the historical data. The value of this approach has been questioned; see discussion

(Green)
VTSMX Vanguard Total Stock Mkt Idx Inv 30.00%
FSIIX Fidelity International Index Investor 30.00% (developed markets only)
VBMFX Vanguard Total Bond Market Index Inv 40.00%

(Red)
VTSMX Vanguard Total Stock Mkt Idx Inv 30.00%
VGTSX Vanguard Total Intl Stock Index Inv 30.00% (developed and emerging at cap weight)
VBMFX Vanguard Total Bond Market Index Inv 40.00%

Image
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.
There is definitely some cognitive dissonance here. You claiming the market is giving emerging markets the benefit of the doubt is a positive claim demanding evidence. It is, quite literally, a claim that you know more than the market. Regarding the limited effectiveness of creative accounting, it has little to do with anything the SEC is doing so yes, it applies fairly well to emerging markets. It isn’t a function of institutions. The market evaluates he reliability of data and prices accordingly.
Last edited by KyleAAA on Sat Jan 12, 2019 5:18 pm, edited 2 times in total.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 5:14 pm

drk wrote:
Sat Jan 12, 2019 5:05 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Actually, I'm not assuming I know anything more than the market. [...] In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet.
Here, I bolded the faulty assumption for you.
Hi and thanks for your reply. In my book, it's false until proven otherwise, although I respect the opposite view that it's true until proven otherwise. The very reason for my original post was to challenge this assumption that you've bolded. It's not dogma, nor something I mindlessly take for granted. I'd like to hear the arguments in favour of the idea that the market knows something of the actual earnings of companies in emerging markets. This is why I wrote the post.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Dantes » Sat Jan 12, 2019 5:15 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Dantes wrote:
Sat Jan 12, 2019 4:54 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

South Sea Company was a single company, not a mutual fund.
That's right. What point are you trying to make? : )
I don't think the experience of a single company is relevant to emerging markets any more than Enron is an argument against investing in domestic equity. If someone had invested in an 18th century emerging markets fund - which also owned shares in the Hudson's Bay Company and the East India Company - then they would not have been totally wiped out.

So the point I was trying to make is that an investment in the South Seas Company - which was your example - is not equivalent to investing in an emerging markets fund today. It would be the equivalent to investing in a single stock that is too good to be true in a country with a corrupt government and little meaningful regulation.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by KyleAAA » Sat Jan 12, 2019 5:16 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 5:14 pm
drk wrote:
Sat Jan 12, 2019 5:05 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Actually, I'm not assuming I know anything more than the market. [...] In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet.
Here, I bolded the faulty assumption for you.
Hi and thanks for your reply. In my book, it's false until proven otherwise, although I respect the opposite view that it's true until proven otherwise. The very reason for my original post was to challenge this assumption that you've bolded. It's not dogma, nor something I mindlessly take for granted. I'd like to hear the arguments in favour of the idea that the market knows something of the actual earnings of companies in emerging markets. This is why I wrote the post.
It’s neither. A proposition is true or false regardless of whether or not it can be proven. It is irrational to assume it is false until proven true. The most you can say is that you don’t know.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by staythecourse » Sat Jan 12, 2019 5:18 pm

drk wrote:
Sat Jan 12, 2019 3:32 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Am I claiming I know something that the market doesn't? Certainly not
Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, or course, but you may want to avoid introducing cognitive dissonance.
Agreed.

Good luck.
"The stock market [fluctuation], therefore, is noise. A giant distraction from the business of investing.” | -Jack Bogle

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by samsdad » Sat Jan 12, 2019 5:24 pm

[deleted]
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by nisiprius » Sat Jan 12, 2019 5:26 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
...Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?...
It is hard to analogize conditions in 1720 to those today. But the straight answer to your question is, yes, if the South Seas company were subject to SEC regulations, and was a listed stock on a major US stock exchange, I would expect it to be included in the Vanguard Total Stock Market Index Fund and thus I would expect to have bought some.

I definitely owned some Enron stock in 2001, by virtue of its inclusion in Total Stock. To the best of my recollection I never even bothered to figure out how much the decline in its stock price from $90/share to $1/share affected me personally.

Now, suppose that I got a clear warning in 2000 that it was a grotesquely overvalued, fraudulent stinker. What would I have done? I would have just shrugged and said, "well, it is only $60 billion in a total market cap of about $12 trillion or 0.5% of my portfolio, if it goes to zero Total Stock will only go down 0.5%, and it goes up and down more than that almost every day."

I just shrug, and buy index funds. I know they are bound to have stinkers in them and I accept that, because I'm convinced a) that it's good enough, and b) that I cannot do better. I also shrug and settle for what Vanguard decides to do in its big index funds. If they use a CRSP index, find. If they use a FTSE index, fine. Their big "total international" fund has emerging markets, so, hey, I have emerging markets. If I decided to stick with Fidelity ten or so years ago, when their big "international index fund," FSIIX did not have emerging markets, that's what I'd probably have, and I'd probably be sticking with it on the principle of staying the course.
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 5:27 pm

KyleAAA wrote:
Sat Jan 12, 2019 5:13 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
drk wrote:
Sat Jan 12, 2019 3:32 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Am I claiming I know something that the market doesn't? Certainly not
Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, or course, but you may want to avoid introducing cognitive dissonance.
Actually, I'm not assuming I know anything more than the market. I'm just not convinced I want to give emerging markets the benefit of the doubt, whereas the market partially does. In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet. Imagine a man had a coin that he was going to flip. The man allows the market to bet on the outcome "heads" only (not tails), and does not allow the market to inspect the coin to make sure it's not biased in favour of tails. The man assures the market that if the market loses the bet, he will only charge him half. Were both the coin and the man fair, the market would win twice as much on heads than he would lose on tails. Sure, the market may say "10 bucks on heads!", but unlike the market, I will abstain on the bet. The market gives the benefit of the doubt to the man with the coin, but I don't. Do I need to believe I know more than the market to make this decision? No I don't.
mtn biker wrote:
Sat Jan 12, 2019 3:14 pm
I think the reason they are "cheap" right now is exactly because of all you said. The possibility that it is actually cheap and not just cheap on paper is a reason to buy. The possibility not enough of those markets will show growth is a reason to avoid a large percentage of your assets in the area.

All emerging markets do not have to do well in order for a good return, just like all investments by venture capitalists do not do well, matter of fact, most do poorly. But there is the decent chance that a small percent will do phenomenally well, which can more than offset the underperformance of the bulk. You didn't need to just buy FANG stock 10 years ago to beat the full index, if you bought all technology stocks you still beat the full index. More importantly, if you had avoided tech stocks 10 years ago you would have greatly underperformed. Same thing here. Over 10 years maybe EM will perform greatly, maybe not, but unless it's part of your portfolio you cannot benefit, and to avoid it is to actively bet against it. I don't claim to know whether EM is cheap or not, but by owning a piece I am keeping my position more neutral, as apposed to betting for or against.
Fair point, I understand the view that "The possibility that it is actually cheap and not just cheap on paper is a reason to buy." and I respect it.

I don't think avoiding a market is actively betting against it in the same way that, for example, short-selling it would be. I would not accuse you of betting against Bitcoin if you refused to buy any bitcoin (especially if your grounds for refusing to buy bitcoin are that the world of Bitcoin is so obscure that you don't want your money to have anything to do with it). You would be betting against it if you short-sold it.
sambb wrote:
Sat Jan 12, 2019 3:50 pm
Enron happened in the USA. GE his happening now here with regards to valuation. Buyer beware in the s and p 500 of the USA also.
Absolutely. If it's happening in the USA, imagine how it must happen elsewhere in places where institutions are probably not as solid as in the USA.
KyleAAA wrote:
Sat Jan 12, 2019 3:23 pm
In general, the market is intelligent enough to account for fraud and bake it into valuations. There are exceptions, of course, but even in prominent cases like Enron it was known there was fraud taking place by forensic accountants at least a year or two prior to the collapse. Why the market didn’t price in that information, I don’t know. Or maybe it did. There is also FAR more data to go on these days than even 15 years ago. The market is good at what it does. The actual effectiveness of creative accounting in fooling the market these days is quite low.
Your last sentence does not surprise me, after all the SEC is doing a good job. Do you think that's the case in emerging markets too? Why or why not?
nisiprius wrote:
Sat Jan 12, 2019 4:01 pm
[...]
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.
There is definitely some cognitive dissonance here. You claiming the market is giving emerging markets the benefit of the doubt is a positive claim demanding evidence. It is, quite literally, a claim that you know more than the market. Regarding the limited effectiveness of creative accounting, it has little to do with anything the SEC is doing so yes, it applies fairly well to emerging markets. It isn’t a function of institutions. The market evaluates he reliability of data and prices accordingly.
I do appreciate your attempt at psychologising, but I think you've misinterpreted the purpose of my post. You claim that my claim is a positive one that demands evidence. That would be correct, but only if I were trying to convince you of this claim. That's not what I'm doing. I'm telling you "I may or may not be right, but this is what I believe in right now. You're most welcome to try and prove me wrong. If I am wrong, and you prove me wrong, it could save me some money."

Oof, people on this forum are bloody aggressive.
Best regards,
Last edited by Nicolas Perrault on Sat Jan 12, 2019 5:47 pm, edited 1 time in total.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 5:30 pm

KyleAAA wrote:
Sat Jan 12, 2019 5:16 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 5:14 pm
drk wrote:
Sat Jan 12, 2019 5:05 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
Actually, I'm not assuming I know anything more than the market. [...] In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet.
Here, I bolded the faulty assumption for you.
Hi and thanks for your reply. In my book, it's false until proven otherwise, although I respect the opposite view that it's true until proven otherwise. The very reason for my original post was to challenge this assumption that you've bolded. It's not dogma, nor something I mindlessly take for granted. I'd like to hear the arguments in favour of the idea that the market knows something of the actual earnings of companies in emerging markets. This is why I wrote the post.
It’s neither. A proposition is true or false regardless of whether or not it can be proven. It is irrational to assume it is false until proven true. The most you can say is that you don’t know.
It's not irrational. It's just a device to hear arguments from both sides. I say A and ask you to present me arguments for not A. Then I say not A and ask you to present arguments for A.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by ignition » Sat Jan 12, 2019 5:33 pm

Aren't most of the firms in emerging markets audited by the Big Four? The same Big Four that audits firms in developed markets?

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by hdas » Sat Jan 12, 2019 5:35 pm

on a positive note, the new bond king :confused proclaims:
It’s a time to invest in emerging markets “relativistically,” Gundlach said. Emerging market stocks will beat the S&P 500 Index if the U.S. dollar weakens.
"whenever there is a randomized way of doing something, then there is a nonrandomized way that delivers better performance but requires more thought" ET Jaynes

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 5:45 pm

nisiprius wrote:
Sat Jan 12, 2019 5:26 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
...Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?...
It is hard to analogize conditions in 1720 to those today. But the straight answer to your question is, yes, if the South Seas company were subject to SEC regulations, and was a listed stock on a major US stock exchange, I would expect it to be included in the Vanguard Total Stock Market Index Fund and thus I would expect to have bought some.

I definitely owned some Enron stock in 2001, by virtue of its inclusion in Total Stock. To the best of my recollection I never even bothered to figure out how much the decline in its stock price from $90/share to $1/share affected me personally.

Now, suppose that I got a clear warning in 2000 that it was a grotesquely overvalued, fraudulent stinker. What would I have done? I would have just shrugged and said, "well, it is only $60 billion in a total market cap of about $12 trillion or 0.5% of my portfolio, if it goes to zero Total Stock will only go down 0.5%, and it goes up and down more than that almost every day."

I just shrug, and buy index funds. I know they are bound to have stinkers in them and I accept that, because I'm convinced a) that it's good enough, and b) that I cannot do better. I also shrug and settle for what Vanguard decides to do in its big index funds. If they use a CRSP index, find. If they use a FTSE index, fine. Their big "total international" fund has emerging markets, so, hey, I have emerging markets. If I decided to stick with Fidelity ten or so years ago, when their big "international index fund," FSIIX did not have emerging markets, that's what I'd probably have, and I'd probably be sticking with it on the principle of staying the course.
This brings us back to your point 2 above, the decision is not that important. Make one decision, then stick to it, it won't matter that much one way or the other.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 5:49 pm

ignition wrote:
Sat Jan 12, 2019 5:33 pm
Aren't most of the firms in emerging markets audited by the Big Four? The same Big Four that audits firms in developed markets?
What's the Big Four?

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by jhfenton » Sat Jan 12, 2019 5:55 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 5:49 pm
ignition wrote:
Sat Jan 12, 2019 5:33 pm
Aren't most of the firms in emerging markets audited by the Big Four? The same Big Four that audits firms in developed markets?
What's the Big Four?
https://en.wikipedia.org/wiki/Big_Four_accounting_firms

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by alex_686 » Sat Jan 12, 2019 6:15 pm

ignition wrote:
Sat Jan 12, 2019 5:33 pm
Aren't most of the firms in emerging markets audited by the Big Four? The same Big Four that audits firms in developed markets?
Not sure about that, but most have sponsored ADR, which means they must file audited reports under US standards, reviewed by the SEC.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 6:22 pm

bluquark wrote:
Sat Jan 12, 2019 5:02 pm
The concerns you're raising are in the category of "known unknowns". Everybody trying to price EM takes them into consideration. Some may mostly dismiss them, some may discount the price a great deal because of it.

Known unknowns always create a risk both on the upside and on the downside. So your argument hinges on your claim that there is an overall rose-colored view, and that therefore the risk is mostly to downside. But I don't see what supports that. On the contrary, I can formulate an argument that the bias is mostly bearish as follows: studies have shown investors, including institutional investors, have a strong home bias, and EM are the countries low on domestic investors, therefore they are the countries who wind up overall underinvested in due to home bias.

Secondly, you should actually look at the list of countries on the EM list. The real basket cases are in "frontier" -- the word "emerging" is bit dated and most of them are already rather developed and on reasonably stable footing today.
This is one of the good answers I've received. Thanks for your opinion.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by DeadPoets » Sat Jan 12, 2019 6:27 pm

I also avoid emerging markets for the reasons OP stated. However, these 2nd and 3rd world countries have a greater chance of “emerging” today thanks to all the advancements in technology.

So if there was a good reason to invest in EM I would say that’s it.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Elysium » Sat Jan 12, 2019 6:30 pm

For all this esoteric talk based on valuations and numbers, it is worth noting that the so called Emerging Markets funds are essentially an investment in just about 4 large countries, 3 if you consider China/Taiwan as one economic block.

Take a look at the country allocation for Vanguard EM Index fund:
China 35%
Taiwan 15%
India 12%
Brazil 8%

That's 70% of the investment in 4 countries right there, out of which 50% is China/Taiwan.

Does anyone believe China, India, and Brazil doesn't matter, that the companies operating in these countries aren't competent enough globally, or they are not headed by savvy executives who are as competent as their developed market counterparts. These are companies with global operations, and a huge footprint. Some of those CEO's are in the Forbes wealthiest list, and the companies they are heading will qualify as top holdings in a global index based on market capitalizations.

Someone need to break the news to them they are only "emerging" and may not make it to the global stage. :oops:

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by harvestbook » Sat Jan 12, 2019 7:36 pm

The US used to be an emerging market yet plenty of people here are all in on the US. I guess it depends on your time frame.
I'm not smart enough to know, and I can't afford to guess.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by UpperNwGuy » Sat Jan 12, 2019 8:05 pm

I don't care whether or not a market is "fairly valued." All I care about is the market value.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by KyleAAA » Sat Jan 12, 2019 8:43 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 5:27 pm
KyleAAA wrote:
Sat Jan 12, 2019 5:13 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
drk wrote:
Sat Jan 12, 2019 3:32 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Am I claiming I know something that the market doesn't? Certainly not
Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, or course, but you may want to avoid introducing cognitive dissonance.
Actually, I'm not assuming I know anything more than the market. I'm just not convinced I want to give emerging markets the benefit of the doubt, whereas the market partially does. In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet. Imagine a man had a coin that he was going to flip. The man allows the market to bet on the outcome "heads" only (not tails), and does not allow the market to inspect the coin to make sure it's not biased in favour of tails. The man assures the market that if the market loses the bet, he will only charge him half. Were both the coin and the man fair, the market would win twice as much on heads than he would lose on tails. Sure, the market may say "10 bucks on heads!", but unlike the market, I will abstain on the bet. The market gives the benefit of the doubt to the man with the coin, but I don't. Do I need to believe I know more than the market to make this decision? No I don't.
mtn biker wrote:
Sat Jan 12, 2019 3:14 pm
I think the reason they are "cheap" right now is exactly because of all you said. The possibility that it is actually cheap and not just cheap on paper is a reason to buy. The possibility not enough of those markets will show growth is a reason to avoid a large percentage of your assets in the area.

All emerging markets do not have to do well in order for a good return, just like all investments by venture capitalists do not do well, matter of fact, most do poorly. But there is the decent chance that a small percent will do phenomenally well, which can more than offset the underperformance of the bulk. You didn't need to just buy FANG stock 10 years ago to beat the full index, if you bought all technology stocks you still beat the full index. More importantly, if you had avoided tech stocks 10 years ago you would have greatly underperformed. Same thing here. Over 10 years maybe EM will perform greatly, maybe not, but unless it's part of your portfolio you cannot benefit, and to avoid it is to actively bet against it. I don't claim to know whether EM is cheap or not, but by owning a piece I am keeping my position more neutral, as apposed to betting for or against.
Fair point, I understand the view that "The possibility that it is actually cheap and not just cheap on paper is a reason to buy." and I respect it.

I don't think avoiding a market is actively betting against it in the same way that, for example, short-selling it would be. I would not accuse you of betting against Bitcoin if you refused to buy any bitcoin (especially if your grounds for refusing to buy bitcoin are that the world of Bitcoin is so obscure that you don't want your money to have anything to do with it). You would be betting against it if you short-sold it.
sambb wrote:
Sat Jan 12, 2019 3:50 pm
Enron happened in the USA. GE his happening now here with regards to valuation. Buyer beware in the s and p 500 of the USA also.
Absolutely. If it's happening in the USA, imagine how it must happen elsewhere in places where institutions are probably not as solid as in the USA.
KyleAAA wrote:
Sat Jan 12, 2019 3:23 pm
In general, the market is intelligent enough to account for fraud and bake it into valuations. There are exceptions, of course, but even in prominent cases like Enron it was known there was fraud taking place by forensic accountants at least a year or two prior to the collapse. Why the market didn’t price in that information, I don’t know. Or maybe it did. There is also FAR more data to go on these days than even 15 years ago. The market is good at what it does. The actual effectiveness of creative accounting in fooling the market these days is quite low.
Your last sentence does not surprise me, after all the SEC is doing a good job. Do you think that's the case in emerging markets too? Why or why not?
nisiprius wrote:
Sat Jan 12, 2019 4:01 pm
[...]
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.
There is definitely some cognitive dissonance here. You claiming the market is giving emerging markets the benefit of the doubt is a positive claim demanding evidence. It is, quite literally, a claim that you know more than the market. Regarding the limited effectiveness of creative accounting, it has little to do with anything the SEC is doing so yes, it applies fairly well to emerging markets. It isn’t a function of institutions. The market evaluates he reliability of data and prices accordingly.
I do appreciate your attempt at psychologising, but I think you've misinterpreted the purpose of my post. You claim that my claim is a positive one that demands evidence. That would be correct, but only if I were trying to convince you of this claim. That's not what I'm doing. I'm telling you "I may or may not be right, but this is what I believe in right now. You're most welcome to try and prove me wrong. If I am wrong, and you prove me wrong, it could save me some money."

Oof, people on this forum are bloody aggressive.
Best regards,
I do not see how your motivation for asking makes a difference. I see no reason to accept your premise absent evidence.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by BuyAndHoldOn » Sat Jan 12, 2019 8:48 pm

Elysium wrote:
Sat Jan 12, 2019 6:30 pm
For all this esoteric talk based on valuations and numbers, it is worth noting that the so called Emerging Markets funds are essentially an investment in just about 4 large countries, 3 if you consider China/Taiwan as one economic block.
While not in the FTSE/Vanguard Emerging Markets Index, South Korea is part of the commonly-used MSCI EM index - which just would tilt those % further towards Asia (and another economy that is large/mostly emerged, at least to global relevance).

My question for the OP/this audience is: What are the likes of GMO (etc.) missing when they recommend Emerging Markets as a value play? I am not saying the OP's points are invalid (they are not), but rather: What are the other sophisticated investors of the world missing if they too want to invest in Emerging Markets equities? How do they live with the risk/reward trade-off, particularly when citing *financial valuation* - relying on financial reporting - as one of the compelling reasons to invest in EM?

Maybe this question is objectionable as it "calls for speculation", but I at least wanted to bring this up.

I would also add that Vanguard is very cautious on EM, and their in-house valuation metrics consider EM overvalued (At least as of the 2019 Forecast).

Reference to GMO, since I specifically mentioned them: https://www.institutionalinvestor.com/a ... ng-markets

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Nicolas Perrault
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Nicolas Perrault » Sat Jan 12, 2019 8:52 pm

KyleAAA wrote:
Sat Jan 12, 2019 8:43 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 5:27 pm
KyleAAA wrote:
Sat Jan 12, 2019 5:13 pm
Nicolas Perrault wrote:
Sat Jan 12, 2019 4:40 pm
drk wrote:
Sat Jan 12, 2019 3:32 pm


Yes, you literally are. Your contention depends on the unproven assumption "emerging markets cannot be fairly valued," whereas the market thinks that they can be. You're welcome to operate under that assumption, or course, but you may want to avoid introducing cognitive dissonance.
Actually, I'm not assuming I know anything more than the market. I'm just not convinced I want to give emerging markets the benefit of the doubt, whereas the market partially does. In a world where the market knows nothing at all about the earnings of companies, the market is going to make a more or less uninformed bet. Imagine a man had a coin that he was going to flip. The man allows the market to bet on the outcome "heads" only (not tails), and does not allow the market to inspect the coin to make sure it's not biased in favour of tails. The man assures the market that if the market loses the bet, he will only charge him half. Were both the coin and the man fair, the market would win twice as much on heads than he would lose on tails. Sure, the market may say "10 bucks on heads!", but unlike the market, I will abstain on the bet. The market gives the benefit of the doubt to the man with the coin, but I don't. Do I need to believe I know more than the market to make this decision? No I don't.
mtn biker wrote:
Sat Jan 12, 2019 3:14 pm
I think the reason they are "cheap" right now is exactly because of all you said. The possibility that it is actually cheap and not just cheap on paper is a reason to buy. The possibility not enough of those markets will show growth is a reason to avoid a large percentage of your assets in the area.

All emerging markets do not have to do well in order for a good return, just like all investments by venture capitalists do not do well, matter of fact, most do poorly. But there is the decent chance that a small percent will do phenomenally well, which can more than offset the underperformance of the bulk. You didn't need to just buy FANG stock 10 years ago to beat the full index, if you bought all technology stocks you still beat the full index. More importantly, if you had avoided tech stocks 10 years ago you would have greatly underperformed. Same thing here. Over 10 years maybe EM will perform greatly, maybe not, but unless it's part of your portfolio you cannot benefit, and to avoid it is to actively bet against it. I don't claim to know whether EM is cheap or not, but by owning a piece I am keeping my position more neutral, as apposed to betting for or against.
Fair point, I understand the view that "The possibility that it is actually cheap and not just cheap on paper is a reason to buy." and I respect it.

I don't think avoiding a market is actively betting against it in the same way that, for example, short-selling it would be. I would not accuse you of betting against Bitcoin if you refused to buy any bitcoin (especially if your grounds for refusing to buy bitcoin are that the world of Bitcoin is so obscure that you don't want your money to have anything to do with it). You would be betting against it if you short-sold it.
sambb wrote:
Sat Jan 12, 2019 3:50 pm
Enron happened in the USA. GE his happening now here with regards to valuation. Buyer beware in the s and p 500 of the USA also.
Absolutely. If it's happening in the USA, imagine how it must happen elsewhere in places where institutions are probably not as solid as in the USA.
KyleAAA wrote:
Sat Jan 12, 2019 3:23 pm
In general, the market is intelligent enough to account for fraud and bake it into valuations. There are exceptions, of course, but even in prominent cases like Enron it was known there was fraud taking place by forensic accountants at least a year or two prior to the collapse. Why the market didn’t price in that information, I don’t know. Or maybe it did. There is also FAR more data to go on these days than even 15 years ago. The market is good at what it does. The actual effectiveness of creative accounting in fooling the market these days is quite low.
Your last sentence does not surprise me, after all the SEC is doing a good job. Do you think that's the case in emerging markets too? Why or why not?
nisiprius wrote:
Sat Jan 12, 2019 4:01 pm
[...]
Re Point 1) Do you believe that, perhaps, under these assumptions you would have bought South Sea stock in 1720? You would not have if you had demanded fair value. The fair value of the company was, after all, easy to evaluate, because all of its actual earnings came from the British government and left a paper trail. After the bubble burst, the price fell to that fair value. Do you think you could make the claim that the participants in the South Sea bubble were rational, both insiders and outsiders, because most of them intended to sell to a greater fool?

Re Point 2) Very interesting. I guess you shouldn't overthink it. Just make a decision and stick to it.
There is definitely some cognitive dissonance here. You claiming the market is giving emerging markets the benefit of the doubt is a positive claim demanding evidence. It is, quite literally, a claim that you know more than the market. Regarding the limited effectiveness of creative accounting, it has little to do with anything the SEC is doing so yes, it applies fairly well to emerging markets. It isn’t a function of institutions. The market evaluates he reliability of data and prices accordingly.
I do appreciate your attempt at psychologising, but I think you've misinterpreted the purpose of my post. You claim that my claim is a positive one that demands evidence. That would be correct, but only if I were trying to convince you of this claim. That's not what I'm doing. I'm telling you "I may or may not be right, but this is what I believe in right now. You're most welcome to try and prove me wrong. If I am wrong, and you prove me wrong, it could save me some money."

Oof, people on this forum are bloody aggressive.
Best regards,
I do not see how your motivation for asking makes a difference. I see no reason to accept your premise absent evidence.
I'm not asking you to accept this premise, I'm asking you to challenge it. This you've done, but without advancing any evidence whatsoever.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by AlohaJoe » Sat Jan 12, 2019 8:59 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
I had the chance to visit Fiji about ten years ago.
What does Fiji have to do with emerging markets? Fiji isn't an emerging market.

I'm confused about the relevance of your anecdote.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by whodidntante » Sat Jan 12, 2019 9:08 pm

Elysium wrote:
Sat Jan 12, 2019 6:30 pm
For all this esoteric talk based on valuations and numbers, it is worth noting that the so called Emerging Markets funds are essentially an investment in just about 4 large countries, 3 if you consider China/Taiwan as one economic block.

Take a look at the country allocation for Vanguard EM Index fund:
China 35%
Taiwan 15%
India 12%
Brazil 8%

That's 70% of the investment in 4 countries right there, out of which 50% is China/Taiwan.
I don't think float weighting is ideal for emerging markets or for markets that already hatched. I have a slug of of FNDE SCHWAB FUNDAMENTAL EMERGING MARKETS LARGE COMPANY INDEX and the country weightings are much different in that fund, for example. The MSCI factor indexes are wimpy though, in that they reintroduce price.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by rkhusky » Sat Jan 12, 2019 9:14 pm

When I invest in emerging markets through a mutual fund, I trust that my mutual fund company and the index provider have done due diligence on the stocks in the index. I further trust that there are thousands of people and stock companies actively investing in those EM companies, who are looking for any edge that will earn them money. I trust that, while there could be a few undetected fraudulent companies, most have been adequately investigated by individual investors, mutual fund companies, brokerages, index providers, and/or international government agencies, such that the entire index is very unlikely to be significantly affected by fraud.

Further, the same is true of Developed Markets and US mutual funds. I have no expertise in reading SEC reports, balance sheets or the like, to prove to myself or anyone else that any stock is fairly valued. As for me, fairly valued = market value.
Last edited by rkhusky on Sat Jan 12, 2019 9:26 pm, edited 3 times in total.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by stan1 » Sat Jan 12, 2019 9:20 pm

bluquark wrote:
Sat Jan 12, 2019 5:02 pm
Secondly, you should actually look at the list of countries on the EM list. The real basket cases are in "frontier" -- the word "emerging" is bit dated and most of them are already rather developed and on reasonably stable footing today.
The Vanguard Emerging Markets Fund is almost half a two China fund. The PRC and ROC (Taiwan) amount to almost 50% of it since South Korea got promoted out.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by Dialectical Investor » Sat Jan 12, 2019 9:43 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm

Am I claiming I know something that the market doesn't? Certainly not, but in terms of emerging markets --- in a way that would parallel cryptocurrency --- I wonder whether the market knows enough to estimate the worth of emerging market stocks to the closest order of magnitude.
Since the market doesn't even know enough to estimate accurately the worth of stocks in developed countries like the United States, I wouldn't worry too much about what the market does or does not know about emerging markets.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by develop » Sat Jan 12, 2019 9:44 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Perhaps the markets of countries where the institutions were solid enough and the people honest enough to allow fruitful investing all have already emerged. I have serious doubts that any of the remaining markets will do so in the next century. The institutional and cultural backbone might just not be there.
bold and underline mine

I'm going to give benefit of the doubt here and assume that you didn't mean that the way I read it. Surely you didn't mean that people who live in developing countries are generally dishonest by nature? Forgive me for misunderstanding.
I had the chance to visit Fiji about ten years ago. In a supermarket, I grabbed a box of Frosted Flakes, even though the price of the item was nowhere to be found on the box or on the shelf. It went at the cash register for 12 dollars and the store would not accept a return. I swore never again to buy anything without knowing the price.
If you had been saying that people who live in developing countries are inherently dishonest, certainly you wouldn't have based that on having been to Fiji once.

It definitely sounds like you got a bad deal - if not ripped off - on the Frosted Flakes. Of course, that says nothing about 3 billion other people.

develop
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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by develop » Sat Jan 12, 2019 9:51 pm

HalfMillionaire wrote:
Sat Jan 12, 2019 5:08 pm
I don't think any people have a monopoly on being honest or having a cultural backbone (bolding by me in the excerpt below). It would come as a shock to China (world's largest economy by PPP) and India (3rd largest by PPP) that they have been lacking in honest people and cultural backbone.

The desire to have a better future is universal. Every society is trying to address their specific challenges and make life better for the coming generation. Some have more challenges than others - but making moral judgements and sweeping generalizations is uncalled for.
Nicolas Perrault wrote:
Sat Jan 12, 2019 2:46 pm
Perhaps the markets of countries where the institutions were solid enough and the people honest enough to allow fruitful investing all have already emerged. I have serious doubts that any of the remaining markets will do so in the next century. The institutional and cultural backbone might just not be there.
Sorry; HalfMillionaire got to this way before me!

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by nisiprius » Sat Jan 12, 2019 9:52 pm

BuyAndHoldOn wrote:
Sat Jan 12, 2019 8:48 pm
My question for the OP/this audience is: What are the likes of GMO (etc.) missing when they recommend Emerging Markets as a value play?
From another thread, GMO 7 year forecasts are worse than a toss of a coin

Image

What were they missing when they predicted that emerging markets would return 7.6% annualized, when they actually returned 0.7% annualized? Well, if you invested $10,000, they were predicting you'd have $16,700, and you actually got $10,500, so my answer is "they were missing about six thousand dollars."

Here is my chart of how their forecasts compared to reality:

Image

And in case your eyes are picking out patterns that aren't there, the correlation between predicted and observed is 0.05, that is to say, virtually none.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness; Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery.


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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by legio XX » Sat Jan 12, 2019 10:07 pm

Nicolas Perrault wrote:
Sat Jan 12, 2019 6:29 pm
I'm not American by the way.
Hockey player? Actor? Explorer?
Am enjoying this exchange. <Nisi, you are a mentor.>
What have I actually done? Thought about EM, endless optimism of the 60s, but never invested in it. Good to rethink every once in a while.

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by fortyofforty » Sat Jan 12, 2019 10:11 pm

harvestbook wrote:
Sat Jan 12, 2019 7:36 pm
The US used to be an emerging market yet plenty of people here are all in on the US. I guess it depends on your time frame.
That might be true. I don't have a couple of centuries for things to sort themselves out, though.
"In a time of universal deceit, telling the truth becomes a revolutionary act." - George Orwell | Diligentia. Vis. Celeritas. - Jeff Cooper | Original Vanguard Diehard

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by dh » Sat Jan 12, 2019 10:54 pm

OP: I would never try to change your mind, as I think every investment decision must be made on your own. I do invest in EM. Not because I "know" it is a better value and will produce a higher return; rather, I am invested in EM to diversify. Still I am certain that someone asked the same question in 2002 about avoiding EM. Check out the Callan Table for what happened during the next few years.

https://www.callan.com/wp-content/uploa ... d_2018.pdf

Will they have higher returns, lower returns, consistent returns going forward, I have absolutely no clue (nor does anyone else). Yet, I choose to stay diversified. As Taylor is fond of stating: there are many roads to Dublin. I wish you well!
:sharebeer

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Re: Emerging markets cannot be fairly valued and investors are better off elsewhere: Change my mind :)

Post by reformed.trader » Sun Jan 13, 2019 12:49 am

If you suspect the financial statement numbers, you can also look at dividend yields(cold hard cash) as a gauge of value or cheapness. Here are some large EM countries...

Russia - 6.3%
China - 4.7%
Taiwan - 4.7%
South Africa - 4.4%
Turkey - 4.2%


For comparison the US is at 2.1%

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