The answer appears to be the developing world, or emerging markets. Granted, whenever someone talks about “emerging markets” they usually wind up focusing on China – which definitely carries a lot of risk in terms of both currency value (fixed by the still communist government) and slowing growth. But throughout the rest of the planet there is opportunity. Lots of it, in fact.
While the US still looks great as a “safe haven” there is plenty of reason for cash to start flowing back to the developing world. But that investment is almost certainly going to be led by US investors given the strength of the US dollar.
One of the features of the “great recession” that officially started in 2008 was the “great convergence” which came with it. From 2008 to 2012, lingering into 2014 most of the growth in the world came in developing nations. Much of the fuel for this came in the form of very cheap US dollars from low interest rates – money that was supposed to spark a recovery at home.
Nevermind. Money doesn’t exactly respect international borders these days.
Since 2012 opportunities in the developing world have not been as attractive to investors. Many of these economies rely on trade surpluses to develop the scratch they need for basic infrastructure investment – and without a strong US economy there was nobody to buy their stuff. What appeared to be solid investments largely didn’t perform as expected.
Since its peak in 2011 the MCSI Emerging Market index has tumbled 30% – much of it in 2015.
This fuels strange effects here in the US, the most prominent being that as the Fed raises interest rates the rates businesses and consumers pay, measured by the 10yr Treasury Bill, should actually fall. Since a rate increase in December became a virtual lock the 10yr interest rate went up from 2.25% to 2.34% in two days, only to fall right back down to 2.25% in eight days. The “safe haven” has definite appeal.
The one thing that could kill this momentum, which is only starting, is the incredible strength of the US Dollar.
There is no sensible way to measure how currencies are over- or under- valued in the world. But there is a silly way which works incredibly well – the Economist magazine’s “Big Mac Index”. It started as a joke in 1985, but a joke founded on solid principle. Theoretically, a commodity that is the same everywhere which can be produced in a local economy with local materials and labor should sell at the same effective price if the conversion between currencies which banks and markets have settled on is the “correct” one.
But, as you might guess, it doesn’t quite work that way.
Currencies rise and fall for their own reasons, based on their own supply and demand. If no one is investing in Mexico, for example, demand for the Peso is low and the value drops. But a solid easily defined thing like a Big Mac should still be the same everywhere.
Based on the cost of a Big Mac in Mexico, the Peso is under-valued by about 30%. And it turns out that nearly every currency everywhere in the world is horribly under-valued. Investors have been moving to US Dollars as rapidly as possible, leaving the rest of the world behind.
This takes us back to the Emerging Market Index, above. Right now, the Price to Earnings ratio (PE) of this index is 12, meaning stocks listed in it are trading at 12 times earnings. The S&P500 is considerably more expensive at a PE of 22. Investors are willing to pay 83% more for the same return if it comes in US Dollars.
That’s a good measure of risk aversion, if nothing else.
This is unlikely to hold forever. There are opportunities around the world in developing nations that someone, somewhere is likely to take advantage of. The rising US Dollar makes the “carry trade”, or borrowing in US Dollars by people in the developing world, very risky. But US investors might be wise to buy equities (stocks) using our money to the same effect.
Could this re-start the “great convergence” between developed and developing world? Maybe. But this time, it will have to be driven by US investors – and they haven’t developed the stomach for it yet. They might yet.