May 4, 2021

Value vs Growth: Indicators Help Time Stock Selection in Emerging Markets

Recently I wrote “Allocating Emerging Markets Based on Value” (April 7, 2021). The analysis was based on the top-down strategy of overweighting cheap emerging markets and underweighting expensive emerging markets based on valuation indicators. The conclusion of the analysis was that over the “long-term”—between January 1997 and February 2021—allocation among emerging markets based on a number of valuation indicators would have led to outperformance over the MSCI Emerging Market Index. However, for the recent 10 years between March 2011 and February 2021, valuation of the market as an investment strategy for allocating emerging markets has not worked. The current paper tries to answer whether the same conclusion has been true for stock selection within the emerging markets. It compares the performance of value versus growth as investment styles for stock selection. In addition, since value and growth styles tend to cycle over time, the paper focuses on indicators which might help tilt an emerging market portfolio either to value or growth for stock selection.

As proxies for value vs growth for stock selection in the emerging markets, we compare the MSCI Emerging Markets Value Index and MSCI Emerging Markets Growth Index. The MSCI Emerging Markets Value and Growth Indexes both capture large and mid-cap securities exhibiting style characteristics across 27 Emerging Markets (EM) countries . The value investment style characteristics for the MSCI Emerging Markets Value Index construction are defined using three variables: price to book value, 12-month forward earnings, and dividend yield. The growth investment style characteristics for the MSCI Emerging Markets Growth Index construction are defined using five variables: long-term forward EPS growth rate, short-term forward EPS growth rate, current internal growth rate, long-term historical EPS growth trend and long-term historical sales per share growth trend.

We use the start date of January 2001 which was when data was available on Bloomberg for the MSCI Emerging Markets Value and Growth Indexes. We compare two 10-year time periods for the MSCI Emerging Markets Indices. We also compare the US Russell Value and Growth Indices during these two time periods.

As can be seen from the FIGURE 1, the MSCI Emerging Markets Value Index outperformed the MSCI Emerging Markets Growth Index between January 2001 and February 2011.

EM countries include Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Kuwait, Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Qatar, Russia, Saudi Arabia, South Africa, Taiwan, Thailand, Turkey and United Arab Emirates.


Emerging Markets 1
Source: MSCI and Bloomberg

FIGURE 2 compares the US Russell Value and Growth Indices during this same time period. The US Russell Value Index outperformed the Russell Growth Index. The early part of this period included the bursting of the bubble.


Emerging Markets 2
Source: Russell and Bloomberg

We also looked at the cumulative performance of these Indexes over the last 10 years from March 2011 to February 2021. Looking at the last 10 years, both the MSCI Emerging Markets Growth Index and the US Russell Growth Index outperformed their respective Value indexes, (FIGURES 3 and 4).


Emerging Markets 3
Source: MSCI and Bloomberg


Emerging Markets 4
Source: Russell and Bloomberg

Since value and growth tend to perform in cycles, are there any indicators which might help in deciding when to overweight value vs growth for stock selection in the emerging markets? In the U.S., we found that there were several U.S. based indicators which had a positive correlation with the outperformance of the Russell Value vs the Russell Growth. FIGURE 5 shows the U.S. based indicators and their long-term correlation between January 1979 and February 2021 with Russell Value outperformance over Russell Growth over the next month, over the next 6 months, and over the next 12 months. The strongest correlation is with Next Year’s GDP Growth.


Emerging Markets 5
Source: Russell, Bloomberg, Heckman Global Advisors

Applying these same indicators to the emerging markets, we found many of the indicators had a positive correlation with the outperformance of the MSCI Emerging Markets Value Index vs Growth Index. These correlations are found in FIGURE 6. As noted above, the data for the MSCI Emerging Markets Indexes starts somewhat later than the data for the Russell Indexes. The indicators which seem the most consistent are 3-Month Change in the PMI, 3-Month Change in the US 10-Year Government Bond Yield, Citi’s Economic Surprise Index, Current Year’s Earnings Forecast, and Next Year’s GDP Forecast. Because of the strong trend downward in US Government 10-year and 2-year yields since the early 1980s, the high correlations with MSCI Emerging Markets Value versus Emerging Markets Growth were disregarded in the evaluation of indicators.


Emerging Markets 6
Source: MSCI, Bloomberg, Heckman Global Advisors

We also looked to see if momentum of the relative performance could be useful in helping guide whether to overweight value versus growth in the emerging markets. In other words, if a style outperformed over the last month, last 6 months, or last 12 months, would that be useful in predicting which style might do better in the future. Previously, we found when looking at the relative US Russell Value versus Growth performance what happened in the last 6 months (trailing relative returns) is the most useful for predicting future relative returns over the next 6 months and 12 months. These correlations are shown in FIGURE 7.


Emerging Markets 7
Source: Russell, Bloomberg, Heckman Global Advisors

We have applied the same methodology to relative performance in Emerging Markets. The results are shown in FIGURE 8. Here the results are even stronger than the results we found for the Russell Indexes indicating the role momentum plays in timing value versus growth in the emerging markets.


Emerging Markets 8
Source: MSCI, Bloomberg, Heckman Global Advisors

If we use the indicators currently to assess value versus growth in emerging markets, as of April 1, we would conclude from FIGURE 9 that conditions exist for value to outperform growth in the emerging markets.


Emerging Markets 9
Source: Heckman Global Advisors

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Model, back-tested or hypothetical performance information, and results do not reflect actual trading or asset or fund advisory management, and the results may not reflect the impact that material economic and market factors may have had, and can reflect the benefit of hindsight, on HGA’s decision-making if HGA were actually managing client’s money. The model performance is shown for informational purposes only and should not be interpreted as actual historical performance of HGA. Neither past actual nor hypothetical performance guarantees future results. No representation is being made that any model will achieve results similar to that shown and there is no assurance that a model that produces attractive hypothetical results on a historical basis will work effectively on a prospective basis. Clients should not rely solely on this performance or any other performance illustrations when making investment decisions. Actual performance may differ from model results. Any reference to performance information that is provided gross of fees does not reflect the deduction of management or advisory fees. Client returns will be reduced by such fees and other expenses that may be incurred in the management of the account. For example, a 0.50% annual fee deducted quarterly (0.125%) from an account with a ten-year annualized growth rate of 5% will produce a net result of 4.4%. Actual performance results will vary from this example. Further, Exchange-Traded Funds that track theses MSCI indexes would be charged expense ratios that would reduce returns. Any chart, graph, or formula should not be used by itself to make any trading or investment decision.
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