Gold grabbed the headlines early this week with its breathtaking 13.6 percent drop between Friday and Monday, but stock markets didn’t fare too well either. The Dow Jones Industrials plunged 265 points on Monday alone, resurrecting fears that a deeper correction may finally be unfolding.
Indeed, the most cyclical of the S&P 500 sectors including: Energy and Materials went from being over-bought last week, to deeply over-sold in just a flash. Meanwhile, the defensive sectors including Consumer Staples and Health Care stocks remain the most over-bought, clinging near recent highs.
That’s a bit of a red flag, because these so-called “defensive” sectors of the market aren’t typically the stocks you see leading the charge to new highs in a healthy bull market.
The recent meltdown in gold, other commodities, and cyclical stocks is signaling that growth prospects are stalling and there’s more uncertainty ahead for the global economy and for investors.
Global Growth Taking a Turn for the Worse
Last week in Money and Markets, I wrote about the Bloomberg U.S. Economic Surprise Index, and how it can be a key leading indicator for the economy and stock prices. The index continues to trend lower, signaling negative economic data still outnumbers positive. But it’s not just U.S. data that is taking a turn for the worse.
Citigroup publishes several economic indices similar to Bloomberg and covering different regions around the world. The vast majority have turned negative, and some are deeply in the red (Japan, Latin America, emerging markets), telling me economic trends have turned down in many global economies.
And Monday’s sharp sell-off in U.S. stocks was due, at least in part, to negative economic data from China over the weekend.
First quarter economic growth in China slowed to 7.7 percent, falling short of forecasts, and down slightly from 7.9 percent growth in the fourth quarter of 2012. Falling imports thanks to recessions in Europe and Japan were partly to blame, but domestic investment slowed too.
In a sign that Chinese consumers may be pulling back, retail sales slumped to 12.6 percent year-over-year in March. Now, that may sound like a healthy number, compared to disappointing domestic retail sales of -0.4 percent in the U.S. last month. But for China it was the lowest monthly reading in over two years.
Consumer Spending Downtrend in China and U.S.
As always, it’s the trend, not the absolute number, that’s most important. And as you can see from the chart above, the trend in Chinese consumption growth is definitely down. Of course the trend in domestic consumption growth here at home is not much better, as shown below.
U.S. retail sales aren’t moving in the right direction either. In fact, the trend above is certainly no friend to our economy, since consumption accounts for 70 percent of U.S. GDP!
But there’s a silver lining to every downtrend. And in the case of slowing global growth, the investment opportunity is the compelling valuation we’re witnessing in stock markets around the world — particularly in the emerging and frontier markets.
Granted, emerging markets continue to underperform U.S. stocks and most other major stock markets. They’re out of favor with investors at the moment, plain and simple. But this neglect is also creating compelling valuations in many emerging stock markets, which as an added bonus also have much higher growth potential.
Neglected Emerging Markets Offer Bargains
In fact, emerging stock markets today offer investors very attractive price-to-earnings ratios that are well below the long run average — and are also a bargain compared to the U.S. and other major developed markets.
Take Hong Kong for example. Due in large part to mainland China’s disappointing economic results, Hong Kong stocks have suffered by association.
In fact, the Hang Seng Index is one of this year’s worst performing stock markets, down 4.5 percent year to date, while the S&P 500 is 12 percent higher. But Hong Kong stocks are trading at a twenty-five percent discount to global stocks — at just 10.4 times estimated 2013 earnings — compared with a price-earnings multiple of 14 for the MSCI World Index. That’s quite a bargain!
Also, China’s Shanghai Composite Index is priced at just 12-times earnings, while stocks in Singapore have a P-E multiple of only 13.2!
|Compared to U.S. stocks, emerging Asian market stocks are selling at a steep discount.|
To gain access to undervalued emerging stock markets, perhaps the easiest investment is through a diversified single-country exchange traded fund (ETF), which can give you a basket of stocks in a single trade.
The iShares Hong Kong Index (EWH) is one to consider for tapping into bargains on the Hang Seng Index. Or to invest in mainland Chinese stocks listed in Hong Kong, you can look into the iShares FTSE China Index (FCHI). Fair warning: Both of these ETFs currently have price trends that look a lot like the downwardly sloping retail sales charts above, which is to be expected for stock markets that are this undervalued.
Nobody can say how long the global economic downshift will last. But when the data surprises begin to turn positive again, watch these fast-growing and undervalued markets for a turnaround in trend; they could enjoy an explosive rebound.