Grantham Mayo Van Otterloo Quarterly Letter: Q2 2018

From GMO:

Emerging Markets—No Reward Without Risk

Executive Summary 

Emerging equities are to a greater extent than volatile than developed marketplace equities. This owes picayune to the volatility of emerging stock markets inwards local price as well as much to a greater extent than to the strong positive correlation betwixt their local stock markets as well as movements inwards their currencies. The bound of 2018 was a classic representative of this, amongst USA dollar forcefulness driving pregnant emerging weakness. Emerging markets exercise exhibit momentum, as well as so it would non live on strange for the weakness to persist for roughly other quarter, although afterward transaction costs the momentum upshot is in all probability non capturable. Our analysis of the underlying fundamentals for emerging markets, on the other hand, gives us confidence that the assumptions behind our forecasts are audio as well as emerging value stocks stand upward for the most attractive property nosotros tin discovery yesteryear a large margin, as well as inwards the longer term nosotros believe valuation is much to a greater extent than predictive of returns for emerging than momentum is. Our models exercise non conduct maintain into trouble organisation human relationship the potential effects of a merchandise war, but spell a merchandise state of war is presumably a negative for emerging assets, it should arguably live on at to the lowest degree every bit negative for USA assets as well as seems unlikely to modify much close the relative attractiveness of emerging markets inwards global portfolio

Emerging markets had a actually lousy 2nd quarter. This was truthful for pretty much whatever index amongst “emerging” inwards the name, regardless of whatever other words were in that location along amongst it. MSCI Emerging Equities (EM) was downward 8%. The JP Morgan EMBI Global Diversified Bond Index (EMBI) difficult currency bond index was downward 3.5%. The JP Morgan GBI-EM Global Diversified+ local debt index (GBI-EM) was downward 10.4%, as well as the JP Morgan ELMI Plus emerging currency index (ELMI) was downward 5.8%. With the S&P 500 upward 3.4% for the quarter as well as MSCI EAFE downward a tame 1.2%, it was thus a pretty tough quarter for our property allotment portfolios given our large bias toward emerging securities as well as against USA equities.

Whenever nosotros conduct maintain a quarter similar this nosotros react yesteryear looking at what happened, why it happened, as well as whether it poses a challenge to the assumptions that caused us to conduct maintain the biases inwards our portfolios inwards the showtime place. In this instance our analysis suggests that what has happened is non especially out of delineate amongst other historical events inwards emerging markets. The lawsuit shows starkly the distinction betwixt emerging as well as developed markets as well as is a demonstration of why nosotros consider emerging markets to live on riskier than other assets that nosotros invest in. Momentum has historically mattered inwards emerging markets, as well as so in that location is roughly argue to aspect that in that location may live on to a greater extent than hurting to come upward inwards the curt term. However, cipher that has happened inwards the markets or to the underlying fundamentals causes us to dubiousness our longer-term thesis that emerging markets are the best investment chance available today yesteryear a substantial margin.

So what happened end quarter, as well as why were emerging markets striking as well as so hard? Simply put, it was a real strong quarter for the USA dollar (USD), amongst the DXY dollar index upward 5%. two That is a 1.1 measure departure event, which makes it a picayune out of the ordinary, but non a truthful outlier. It in all probability comes every bit no surprise that when the USD rises, the USA stock marketplace outperforms non-US markets. But what makes emerging markets unique is the fact that this doesn’t only occur due to the currency translation effect.

This quarter, for example, the currency handbasket of MSCI Emerging brutal yesteryear 4.8%, exactly the same every bit the autumn for the currency handbasket of MSCI EAFE. In other words, spell roughly specific emerging currencies brutal a lot inwards the quarter – the Turkish lira brutal 13.4% as well as the Brazilian existent brutal 10%, for representative – you’d live on hard-pressed to telephone band this a full general instance of emerging currency weakness as well as so much every bit USD strength. But spell MSCI EAFE rose 3.5% inwards local currency terms, slightly outpacing the ascent inwards the S&P 500, MSCI Emerging brutal 3.5% inwards local currency terms. This is par for the course. It is exclusively a mild overstatement to tell that the basic difference betwixt the developed globe as well as the emerging globe is that when a developed globe province has a declining currency, all else equal that is skillful for that country’s stock market, whereas when an emerging province has a declining currency, all else equal that is bad for that country’s stock market....

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