The developing coronavirus in China and its ramifications are undoubtedly giving investors a good excuse to reconsider their ‘Growth’ allocations in their global equity portfolios. The ramifications are still unfolding but suffice to say the earnings and valuation risks related to all growth assets have heightened materially.
Emerging Markets have always played a growth role in portfolios but have consistently disappointed over the last 10 years – lagging the MSCI World Index by 5.79% annually. More recently, the valuation argument has been actively touted as the main reason for staying the course. The unfortunate reality is that the onset of the coronavirus could well have a very meaningful impact on corporate earnings in China – which now represents a little over 34% of the MSCI Emerging Markets Index. In other words – the likelihood that Emerging Markets will have another poor year vs. Developed Markets has just spiked materially – as evidenced by the ~8% decline in Chinese equities earlier this week.
The darling of the Growth cohort has undoubtedly been the Large Cap Global Growth names that have performed brilliantly in recent years. Generally speaking, many global portfolios have plenty of exposure to such names – which have also become very expensive. At the end of January 2020, the MSCI World Growth Index was trading on a forward P/E of 23x which is at a 10 year high and represents a 37% premium to the rest of the market. Could they keep going? Sure – but history tells us that stock markets have a habit of overshooting and reacting to external events that don’t always have anything to do with the companies / sector themselves.
Now might be the time to fall out of love.
At the risk of sounding totally biased – Global SMID Cap equities still offer a very attractive growth alternative to Emerging Markets and Large Cap Growth. They are less crowded and expensive than Large Cap Growth and have materially less earnings risk than Emerging Markets. On the subject of valuation and finding good ‘Value for Money’ at the market highs – the chart below is a good depiction. The MSCI World SMID Cap Index is now trading at the smallest premium to the broader market in 10 years! Food for thought!