Secular Vs. Cyclical

RalphCole_032_web_ by Ralph Cole, CFA Senior Vice President of Research

Our days in the investment management world are spent balancing the benefits of short-term risks, against what we believe to be long-term themes or opportunities. In other words, very favorable long-term (“secular”) investment paradigms are interrupted by transitory (“cyclical”) factors. For example, we believe that over the long-term, stocks will outperform bonds, but there are times when stocks are over-priced and/or the economy lapses into a recession. During these instances, we want to own comparatively more bonds because they would most certainly outperform equities during the inevitable correction.

Those same forces are occurring in the international markets today. While in the near-term we are seeing a rebound in Europe and possibly Japan, the emerging markets continue to lag. Though they face cyclical headwinds in the near-term, we continue to believe that emerging markets offer better growth opportunities over the long-term for equity investors.

India is a perfect example of an emerging market that is facing cyclical headwinds versus positive secular demographics. India is currently experiencing high inflation, a tumbling currency, and a slowing economy. However, over the next 25 years, the working age population in India is set to grow by over 245 million, more than the current working age population in the U.S.* As such, we believe India represents a compelling long-term investment opportunity.

What Is the Difference Between Emerging Markets and Frontier Markets?

For investment purposes, the emerging markets universe is dominated by the “BRIC” countries. Specifically, Brazil, Russia, India and China are large, growing countries that still do not have deep enough capital markets, or refined enough judicial and regulatory systems, to be considered developed. MSCI specifies 17 additional countries with that designation. You can find the complete list by clicking here.

Frontier markets are smaller countries, with even less developed capital markets. Countries such as Argentina, Croatia, Kenya, Saudi Arabia and Vietnam are examples of frontier markets. The complete list can be found by clicking here.

As of late, there has been a dramatic contrast in the fortunes of these two categories as year-to-date, frontier markets are up some 19 percent, while emerging markets are down 10 percent. For investors interested in accessing frontier markets, we advise utilizing a pooled vehicle (mutual fund or ETF), rather than attempting to purchase individual stocks in these countries.

Takeaways for the Week:

  • Though facing some cyclical head winds, we continue to favor both emerging markets and frontier markets over the long-term in client portfolios
  • While not mentioned above, we think the back-up in rates has gotten ahead of itself and bond yields as defined by the 10-year treasury should remain in a 2.50 percent to 3.00 percent trading range in the coming months   

* Source: Merrill Lynch