Wall Street’s tech giants have smashed the competition in recent years
But Nvidia’s boom and crash week is a reminder not everything goes up forever
Franklin Templeton Institute analysis suggests roughed up emerging markets could provide value in the years ahead
Wall Street has led the world with the best performance and earnings growth over the past 15 years, but new research from Franklin Templeton suggests that at current and historic valuations it’s time to consider greater exposure to emerging markets.
Investors haven’t been able to get enough of Apple’s new ChatGPT-infused stock, Nvidia’s extra special AI (artificial intelligence) chips, nor for that fact the less magnificent but no less lunar-launching Super Micro Computer.
Mega tech has been a major driver of the US stock market’s boom run of records – this despite the US economy’s struggle with its own central bank and the weight of high interest rates.
The gains have been so stupendous the talk is turning to dotcom analogies – is there an AI bubble in the post?
Has the US market lost its bearings amid the stratospheric expectations of investors?
I’m not going to answer that question.
Not when there’s a free AI application out there which can do it and not get paid for getting it wrong (or right).
All we know is that Nvidia’s stock fell nearly 13% in just three days this week. (Ok, it’s back recouping some of those hurts already).
But over the last year or so, because we’ve let Nvidia go from chip maker to giant terrifying cookie monster – just one session of those losses amounted to circa US$650bn of market cap evaporation.
It’s a lot of money to not worry about.
Other AI killers gave up some of their (easy made) killings this week, as well. Yes, we’re looking at you, Super Micro Computer (SMC) which some will say ‘crashed’ circa 9% on Monday.
But then, that ‘crash’ would only drag its YTD gains down to a comparatively embarrassing 190%.
In 5 months.
Too big to fail… on its own
This kind of rotation in and out of sectors, themes and/or stocks is totally natural and should be a healthy sign for Wall Street.
But where are we rotating to?
Out of Nvidia and into TSMC or Apple isn’t really much of a ‘rotation’. That looks a lot more to me like a ‘sit on this and spin.’
NVDA’s share price movements now carry so much weight on the S&P500 that the boat looks more vulnerable than ever.
Naturally, with growing returns comes growing angst.
The Mega Magnificents, behind some 60% of the S&P500’s returns, only serve to highlight what the other 493 companies aren’t doing.
Emerging doubts and promises
There’s no doubt US stocks have led the world with the best performance and earnings growth over the past 15 years, but that could all be about to change say Chris Galipeau, senior market strategist and Lukasz Kalwak, senior analyst at the Franklin Templeton Institute.
According to their analysis, it’s now emerging markets which have the strongest projected earnings growth ahead in the next few years.
This is a handy summation of their thesis
For the past decade and a half, the MSCI USA Index has produced the strongest earnings growth on the planet.
Source: Franklin Templeton Institute
From 2009 to 2023, reported earnings from MSCI USA companies have grown 184%.
US earnings growth was better than Japan (129% earnings growth), significantly stronger than Europe (44% earnings growth), and significantly stronger than emerging markets (5% earnings growth).
As a result, the US equity market has substantially outperformed Japan, Europe and emerging markets as a whole, says Chris Galipeau.
“The global earnings situation is changing,” he said.
“US earnings should still be strong, but we think emerging markets offer even better performance potential. Equities in Japan and Europe also look stronger to us than they have in the past 15 years.
“Valuations matter along with earnings. While earnings drive stock prices over time, prices fluctuate as estimated earnings valuations oscillate for extended periods.”
“In our view,” Lukasz Kalwak says, “long-term investors should consider various valuation methods as part of their toolkit.”
Franklin Templeton: EM killing it on the PE
The Franklin Templeton analysts suggest using another valuation method to get a line on where markets are, and where they can go.
The price of stocks relative to earnings growth – known as the PE ratio – a measurement for both historical and forward-looking comparisons.
Galipeau and Kalwak have compared the current price relative to the average earnings growth of the past 10 years, as well as the price relative to expected earnings for 2024, 2025 and 2026.
In the historical comparison, while all markets appear to be undervalued relative to the past 10 years, the gap is the largest for emerging markets.
Source: Franklin Templeton Institute
“Looking forward, emerging markets also appear to have the most attractive PEG ratios relative to expected earnings through 2026,” they argued.
“When comparing equity opportunities, we believe investors may be well served to consider future earnings growth along with valuation measures. Based on our comparisons emerging markets, as represented by the MSCI Emerging Markets Index, show the strongest forward earnings growth combined with the lowest valuation backdrop.
“Regarding valuation, emerging markets appear undervalued, whether one considers the more traditional P/E multiple or if one also contemplates the forward price-to-earnings-growth measure (PEG ratio).”
Here’s an illustration of current, forward price/earnings (P/E) multiples for the US, Europe, Japan and emerging markets relative to their 10-year average multiples.
Valuations relative to earnings growth also favour emerging markets
Another valuation method to consider is the price of stocks relative to earnings growth, which is known as the PEG ratio. We can use this measurement for both historical and forward-looking comparisons.
In FT’s Exhibit 4, compare the current price relative to the average earnings growth of the past 10 years, as well as the price relative to expected earnings for 2024, 2025 and 2026.
Source: Franklin Templeton Institute
In the historical comparison, while all markets appear to be undervalued relative to the past 10 years, the gap is the largest for emerging markets.
Looking forward, emerging markets also appear to have the most attractive PEG ratios relative to expected earnings through 2026, Lukasz says.
“When comparing equity opportunities, we believe investors may be well served to consider future earnings growth along with valuation measures.
“Based on the comparisons shown above, emerging markets, as represented by the MSCI Emerging Markets Index, show the strongest forward earnings growth combined with the lowest valuation backdrop.”
Source: Franklin Templeton Institute
“Regarding valuation, emerging markets appear undervalued, whether one considers the more traditional P/E multiple or if one also contemplates the forward price-to-earnings-growth measure (PEG ratio).”
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