TSP

Emerging markets aren’t included in the TSP, but can be easily purchased with an ETF in an IRA to add diversification to a total net worth. Image: BigTunaOnline/Shutterstock.com

As of this writing, Joe Biden is the projected president-elect. Republicans are expected to maintain control of the U.S. Senate, although a potential run-off election in Georgia still gives Democrats a narrow path to Senate control as well. The outcome of this election will take some time to finalize.

Markets reacted quickly to the news, although it’s unclear if recent market action will “stick” or if this is just a temporary unwinding of various hedges and other positions.

Tech stocks and health care stocks in particular performed very well last week – and positive vaccine trial news from Pfizer added to the rally on Monday. With a Senate that is likely (but not certain) to remain in Republican hands, the market discounted the probability of healthcare reform which could have pressured healthcare stock margins, and discounted the probability of anti-trust activity against Big Tech, which the Democrat-controlled House of Representatives has recently been putting forth.

The S&P 500, which represents the top 500 companies in the United States and is tracked by the C Fund, surged back near all-time highs. Momentum turned rather bullish as well.

However, the key levels to watch are the recent high points in the market, represented with green lines on the following chart. These high points currently represent technical resistance. If the stock market breaks through those, it opens the door for further upside:

Chart Source: YCharts

Passing the Baton of Outperformance?

The U.S. stock market has been the star of the past decade, as the best-performing major equity market in the world. However, each decade tends to have a different set of equity market leaders.

In the 1980’s, foreign developed markets outperformed the rest of the world, with Japan as the star of the show that led into the massive Japanese equity and real estate bubble that dwarfed any other bubble in history.

In the 1990’s, U.S. markets outperformed, and led the way into the well-known 2000 dotcom bubble.

In the 2000’s, emerging markets outperformed, with China, India, Russia, and Brazil leading the way, along with a strong commodities bull market. By 2007, Chinese and Indian equities were on average more expensive than U.S. stocks were during the 2000 dotcom bubble.

In the 2010’s, U.S. markets outperformed again, as tech/internet companies expanded their platforms across the world and changed the way we interact with our phones, the internet, and retailers.

These periods of outperformance tend to start with an undervalued equity market and end with an overvalued equity market, which gives another set of markets an opportunity to do better from a cheaper starting point.

Personally, I’m more bullish on emerging markets over the next decade than I am for United States or foreign developed markets. Emerging markets aren’t included in the TSP, but can be easily purchased with an ETF in an IRA to add diversification to a total net worth, for example.

Emerging markets now contain more than half of the world’s GDP, and most of the world’s GDP growth, but only account for 11% of global equity market value, since they’re pretty cheap relative to earnings.

I figured it would be a good exercise to look at the largest stock by market capitalization of each of the major geographies: US markets, foreign developed markets, and emerging markets.

United States Market Leader: Apple

The biggest company by market capitalization in the United States is Apple. It is worth over $2 trillion, which is staggering.

This next chart shows the stock price of Apple (represented by the black line), compared to its earnings per share over time. The blue line represents the price the stock would be if it were trading at its historical average price-to-earnings ratio. In other words, if the black line goes way above the blue line, it means the stock is a lot more expensive than usual, and if the black line goes below the blue line, it means the stock is cheaper than usual:

Chart Source: F.A.S.T. Graphs

As we can see, in 2020 Apple’s stock price completely decoupled from their fundamentals. Earnings are going up about 10% this year, while the stock price basically doubled.

Apple has a 35x price-to-earnings ratio (compared to the 5-year historical average of 17x), and average annual forward expected earnings growth of 13%. This is considered a rather expensive ratio of valuation vs growth potential. It also pays a 0.69% dividend yield.

The next biggest companies in the United States are Microsoft and Amazon. They are also rather expensive by most valuation metrics.

On average, large companies in the United States have a price-to-earnings ratio of 26x, and a 5-year past earnings growth rate of 14%. The market leaders, like Apple, tend to be more expensive than the average companies in the index, and generally have strong balance sheets.

Foreign Developed Market Leader: Nestle

The top three companies in the MSCI EAFE index, which represents most foreign developed markets and is tracked by the I Fund, are all based in Switzerland. Of these, the biggest one is Nestle, the well-known consumer products company, and it’s worth over $300 billion.

Here is their price vs fundamentals chart:

Chart Source: F.A.S.T. Graphs

Nestle has a price-to-earnings ratio of about 25x, but forward expected annual earnings growth of only 5-6% per year. They also pay a 1.97% dividend yield. It’s not exactly cheap relative to its growth rate, in other words.

The next two biggest companies are Novartis and Roche, which are both healthcare companies. Their valuations are somewhat more attractive by quantitative metrics.

On average, companies in foreign developed markets have a price/earnings ratio of 18, and 5-year annualized earnings growth rates of under 9%.

Emerging Market Leader: Alibaba

The biggest company in emerging markets is Alibaba of China, which is worth over $800 billion. They are an e-commerce company, cloud computing provider, and mobile payments processor:

Alibaba has a price-to-earnings ratio of 33x, but also has 27% expected annual earnings growth over the next three years. If analysts are correct about that (and of course they might not be), it means Alibaba has the best ratio of valuation vs growth of these big three example companies.

The second biggest company in emerging markets is Tencent of China, which is China’s main social media network, internet company, games producer and licensor, and the other mobile payments processor that competes with Alibaba. The third biggest company is Taiwan Semiconductor Manufacturing, which in recent years outperformed Intel in getting to 7nm chip production, and is the largest semiconductor manufacturer in the world.

On average, companies in the emerging market index have a price-to-earnings growth of 16x, and 5-year annualized earnings growth rates of 14%. So, they are quite fast-growing, but also the cheapest. As usual, the top companies tend to be more expensive and faster-growing than the average.

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Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.

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