During the past ten years global stock markets experienced depression-like performance. The aftermath of the Global Financial Crisis was high debt and low growth and ineffective monetary policy despite huge money printing and zero interest rates.
The policies of Central Banks only benefited stocks in the United States where technology and innovation sectors benefitted from low discount rates and earnings were pumped up by tax cuts and stock buybacks. The rest of the world by-and-large saw low earnings growth, declining multiples and weak currencies. Global stocks also started from relatively high valuations and margins, as ten years ago global growth had been highly stimulated by China’s investment boom.
We can see how this developed in the charts below. The first chart shows the performance of the S&P 500 vs the MSCI Emerging Markets stock index. The left side shows the evolution of earnings multiples, the price earnings ratio and the cyclically adjusted price earnings ratio (CAPE, average of 10-year inflation adjusted earnings). Note the remarkable expansion of the U.S. CAPE from 25 to 34, which is the second highest level in history. At the same time the EM CAPE ratio fell from 20 to 15. The right side of the chart shows the evolution of the indexes and earnings. U.S. earnings were basically flat through 2015 and then took off, and, based on forward PE estimates for 2021, will end about double 2010 levels. EM earnings, based on forward PE estimates for 2021, will be at exactly the same level as 2010. Of course, the combination of the evolution of earnings and multiples explains the dramatic outperformance of U.S. stocks.
The following chart provides some granularity within emerging markets. The same charts as above are shown for three primary emerging markets, China, Brazil and Taiwan. Brazil in 2010 was a major beneficiary of the commodity bubble but since then has suffered a vicious case of “Dutch Disease,” the natural resource curse. All other commodity producers (Chile, Peru, Indonesia, S. Africa, Indonesia) went through a similar process, though none as painfully as Brazil. Brazil’s CAPE ratio has fallen from 22 to 12 over the period and earnings in 2021 earnings are expected to still be 60% lower than in 2010.
China has seen a significant reduction in its CAPE ratio which went from 22 in 2010 to 11 in 2016 and 16.8 at year-end 2020. Over this period, the Chinese stock market has transformed itself from heavy with banks and industrials to one dominated by tech. These old economy sectors explain the flat evolution in earnings over the period, but in the future technology and innovation stocks will drive results.
Finally, Taiwan is shown as an example of an outlier. Taiwan, like Korea, is a stock market that is dominated by world-class technology companies. Not surprisingly, its CAPE multiple at year-end 2020 was higher that in 2010 and earnings are up over 50% during the period.
