Cue the “submerging markets” quips. Stock markets in emerging economies have sunk fast this year, the benchmark iShares MSCI Emerging Markets Index (EEM) fund underwater by 13.5% in 2013, trailing the return of the U.S. Standard & Poor’s 500 index by nearly 25 percentage points.
Veteran market strategist Rich Bernstein, founder of Richard Bernstein Advisors, says the emerging markets are likely to get worse before they get better.
Bernstein has been correctly bullish on American stocks and sharply skeptical of the outlook for the developing economies, which he views as being over-dependent on deflating commodity prices and reckless credit creation.
The markets are clearly coming to terms with the fact that global growth is limp and China is not reaccelerating. But Bernstein says big emerging-market companies continue to fall short of analysts’ forecasts, a sign that investors continue to maintain too much faith that the developing-markets’ magical growth story is intact.
The pressing question for stateside investors is whether the tumult in emerging-market stock and bond markets — not to mention the palpitations gripping Japanese financial markets — will reach domestic stocks, which have already wobbled in the face of rising Treasury yields and uneven economic data.
In the attached video from the Morningstar Investment Conference in Chicago, Bernstein — whose firm is sub-advisor of the Eaton Vance Richard Bernstein Equity Strategy Fund (ERBAX) — says he expects “fast money” whipping around world markets to create continued volatility.
But ultimately he’s secure in his long-running bet that U.S. stocks will continue to outperform. Indeed, he figures America will be a net beneficiary of the emerging-market slump, as commodity prices stay slack — bolstering consumer spending and corporate profit margins — and capital flows into U.S. assets.
Count him as bearish on commodities as an investment, too. In a panel discussion at the conference, Bernstein likened investors’ prayerful vigil for a commodity rebound to the misplaced hope and expectation in the early 2000s that technology stocks would inevitably return to glory. Faith in the past decade’s leadership sector dies hard.
But because the rest of the world is struggling, Bernstein isn’t as fond of American large-capitalization multinationals exposed to global demand. He prefers small- and mid-cap shares for their domestic focus. In particular, he favors smaller industrial names that will reap the bounty of a budding manufacturing renaissance in the U.S.
Before launching his firm, Bernstein was the lead investment strategist for Merrill Lynch, a role that gave him a deep appreciation for how professional investor sentiment can stray down blind alleys. At the moment, he thinks investors are far too aggressive in pricing in an imminent hostile turn in Federal Reserve policy.
“The Fed,” he notes, “is always reactive” — a lagging actor responding to economic signals. And in this cycle, he points out, the Fed has been crystal clear that it intends to be “later than usual” in changing course from its all-out monetary stimulus, including its $85 billion monthly “quantitative easing” asset purchases.
As such, don’t expect the recent spike in the 10-year Treasury yield to above 2.2% from 1.7% in several weeks to be the start of a rapid spurt in interest rates.
Rates will trend higher as a function of surer U.S. economic performance, but at a moderate pace — assuming, that is, that we can count on all that fast money to keep these market adjustments orderly.