AQR Capital Management LLC, the $95 billion firm founded by renowned quantitative investor Cliff Asness, says US dominance of equity markets is about to end, ushering in a wave of diversification that will benefit emerging markets for years to come.
(Bloomberg) — AQR Capital Management LLC, the $95 billion firm founded by renowned quantitative investor Cliff Asness, says US dominance of equity markets is about to end, ushering in a wave of diversification that will benefit emerging markets for years to come.
The Greenwich, Connecticut-based manager of quant and hedge funds says its models show developing-nation equities offer the cheapest relative valuations since the turn of the century and will outperform the US over the next decade.
The time has come for investors to cut overweight positions on US equities to a more neutral stance and start buying emerging-market shares, said Dan Villalon, co-head of the firm’s portfolio solutions group.
“If you find something that is cheaper than it’s been in nearly 25 years, it’s worth considering even in spite of the headwinds,” Villalon told Bloomberg in an interview. “For active investors with a value bias, this is about as attractive as we’ve ever seen for emerging equities.”
With stocks from developing nations extending their underperformance into a sixth straight year, MSCI’s emerging-markets gauge trades at a valuation discount of 35% versus the S&P 500 and 53% versus Nasdaq. And the gaps have widened this year: the figures were 30% and 41%, respectively, in January.
AQR’s research showed that for 30 years, US equity outperformance meant dollar-based investors had little incentive to put their money to work outside the country. But the gains weren’t driven by fundamentals; they were boosted by investors’ willingness to pay more for the same dollar of profit in the US than in any other country.
That valuation-driven bull market has gone to such extreme levels that the probability for further outperformance is negligible, the model now suggests.
“We are taking a valuations-based perspective. It’s not going tell you if the US is going to continue to outpace emerging markets next year or even the year after,” said Villalon, who also hosted AQR’s podcast, “The Curious Investor.”
“What we do believe is on average over the next 10 years, EM equities based on valuations should be the relative victor comparing the two markets,” he said.
While the benchmark MSCI emerging markets index has gained 5% this year, rebounding from the worst annual losses since the 2008 financial crisis, it hasn’t matched the pace of equity gains in the US, where the S&P 500 is up 14% and the Nasdaq 100 has soared 38%. Most of the gains for emerging markets have come this month, with the index rising 5.4% in June.
AQR’s model goes beyond headline valuations and analyzes inflation-adjusted earnings and long-term dividend payout ratios relative to market prices. That shows emerging-market stocks are far cheaper than a cursory study of price-to-earnings ratios may show.
“Virtually all US investors I’ve spoken to lately have a meaningful US overweight compared to the truly passive market-cap portfolio,” Villalon said. “We’d like to get people to reconsider that, and maybe bring it back to neutral. For more tactically-oriented investors, they might even take a bit of an overweight to underpriced emerging markets.”
Even if EM stocks underperform in the short-term, that shouldn’t deter investors from rethinking their heavily US-focused portfolios, Villalon said.
“Diversifying beyond your home country isn’t easy, but we think today it’s an especially important part of building a more efficient portfolio,” he said. “AQR is always a fan of diversification and today, we think that the long-term rewards for being diversified are greater than they’ve been in a very long time.”
(Updates with details on firm from first paragraph, market prices.)
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