On the Case for Emerging Market Stocks; Eat Food, Not too Much, Mostly Plants!

From: aditya rana
Date: Sat, Jun 14, 2014 at 2:12 PM
Subject: On the Case for Emerging Market Stocks; Eat Food, Not too Much, Mostly Plants!


Following three years of significant underperformance by emerging market stocks (compared to the developed world), they have recently shown tentative signs of recovery outperforming most of the developed world. Are we in the early stages of a period of outperformance going forward or is this a typical "flash-in-the-pan" rally which is likely to fade out? Ryan Larson from the well known fundamental value research firm Research Affiliates ($169 Billion managed using their strategies) provides a helpful framework to look into this issue further. To summarise:

-Not since the Asian and Russian Crises of ’97-’98 have emerging markets stocks underperformed the US so dramatically – over the last three years the EM Index is down 8.35% while the S&P 500 index is up 50.73% (see chart below).

-Two key factors influence stock market returns – corporate earnings and what multiple investors pay for them. Real earnings per share are about 50% above their long term trend in the US while they are 10% below for emerging markets (implying a zero expected return for the US and 12% p.a. for EM over the next three years). Increased globalization implies that earnings across regions will converge rather than diverge, and EM companies are likely to surprise on the upside compared to currently low expectations.

-EM stocks also look attractive from a valuation perspective – the US market is currently priced at 25*cyclically adjusted P/E (CAPE) while EM stocks are nearly half that level at 14*. A fundamentally weighted (i.e. value rather than market weighted) EM index trades near book value, a level last seen at the depths of the Global Financial Crisis in February, ’09, subsequently rising by 150% until end 2010 (which is unlikely to be repeated but a significant outperformance is feasible).

-Not all EM stocks have been in a bear market – consumer-related and technology stocks have done well, with consumer stocks rising by 26% and outperforming the broad market by 33%. Consumer stocks are currently trading at a 27* P/E and a price-to-book of 3.6*, which are both twice the corresponding multiples for the broader market.

-The technology sector, a play on consumer growth as well, was the best performing sector in emerging markets – rising by almost 40% over the last three years, driven by a small group of internet stocks (Naspers, Tencent and Naver) with P/Es of 90x, 50x, and 80x respectively and P/Bs ranging from 14* to 21*.

-The weakest sector in the EM universe is energy – with a stark difference between the performance of integrated oil companies in the US and those in Brazil and Russia. Over the last three years, US energy stocks rose by 18% while EM energy stocks fell by 33% (see chart below). This difference did not arise from US companies involved in shale oil exploration and production – but from integrated companies like Exxon Mobil and Chevron versus Petrobas, Reliance, Gazprom and CNOOC.

-While momentum might carry overpriced EM consumer and technology stocks further, a contrarian strategy which overweights undervalued stocks (like energy) and underweights overpriced stocks is likely to outperform over the longer run.

-A 2014 study done by Dimson, Marsh and Staunton shows that a country rotation strategy within emerging markets, selling low dividend yielding countries and buying high yielding countries, would have increased annualised returns by 20% over the 38-year period from ’76 until ’13 (see chart below). In addition, buying countries with the weakest currencies would have resulted in a similar excess return.

-The reason that investing in high dividend yields and weak currencies outperforms over time is that these situations are typically caused by fear and pessimism and create opportunities to earn a higher risk premium.

-While emerging market stocks may not be at a "point of maximum pessimism" (as said by John Templeton), but patient long-term value-oriented investors would do well to rebalance into the asset class over the coming months.

A persuasive case for rebalancing in EM stocks, particularly in beaten down countries like China, Russia and Brazil. India should also be a core weighting given that the market is likely in a secular bull uptrend as argued in an earlier piece.

The Telegraph (June 10, ’14) had a interesting pictorial (click on chart below) which values the stocks markets across all countries based on three valuation measure – P/E, CAPE P/E and P/B and then rates them in terms of valuations. To be named “cheap”, markets had to be trading below their own historic valuation across all three measures. Only a handful of stock markets managed to achieve this feat – Greece, China, Hong Kong, India, Japan, Russia and Turkey (you can buy their country ETFs). In red are the countries that scored badly on all three metrics. America, Sri Lanka, Pakistan and Indonesia are all trading on valuations that are higher than their historic averages across each of the measures.

Eat Food, Not too much, Mostly Plants:

To follow-up on last week’s newsletter which provided a convincing rebuttal of the book "The Big Fat Surprise: Why Butter, Meat and Cheese Belong in a Healthy Diet" by one of the world’s foremost nutrition scientists – Dr. David Katz, Director and founder of the Yale Prevention Research Centre, I present below excerpts from a fascinating article referenced in the above piece by journalist Michael Pollan ( it’s a long article written in 2007 and well worth the full read! http://www.nytimes.com/2007/01/28/magazine/28nutritionism.t.html?pagewanted=all&_r=1& ).

– "Eat Food, Not too much, Mostly Plants" is the short answer to the supposedly incredibly complicated and confusing question of what we humans should eat in order to be maximally healthy

– A little meat won’t kill you, though it’s better approached as a side dish than as a main. And you’re much better off eating whole fresh foods than processed food products. That’s what I mean by the recommendation to eat “food.”

– Sooner or later, everything solid you thought you knew about the links between diet and health gets blown away in the gust of the latest study.

– The story of how the most basic questions about what to eat ever got so complicated reveals a great deal about the institutional imperatives of the food industry, nutritional science and journalism, three parties that stand to gain much from widespread confusion.

– Humans deciding what to eat without expert help — something they have been doing with notable success since coming down out of the trees — is seriously unprofitable if you’re a food company, distinctly risky if you’re a nutritionist and just plain boring if you’re a journalist.

-It was in the 1980s that food began disappearing from the American supermarket, gradually to be replaced by “nutrients,” which are not the same thing. New terms like “fibre” and “cholesterol” and “saturated fat” rose to large-type prominence.

– A little-noticed political event in Washington in 1977 seems to have helped propel American food culture down this dimly lighted path. Responding to an alarming increase in chronic diseases linked to diet — including heart disease, cancer and diabetes — a Senate Committee on Nutrition, headed by George McGovern, held hearings on the problem and prepared a document called “Dietary Goals for the United States.”

– The committee learned that while rates of coronary heart disease had soared in America since World War II, other cultures that consumed traditional diets based largely on plants had strikingly low rates of chronic disease. Epidemiologists also had observed that in America during the war years, when meat and dairy products were strictly rationed, the rate of heart disease temporarily plummeted.

– The committee drafted a straightforward set of dietary guidelines calling on Americans to cut down on red meat and dairy products. Within weeks a firestorm, emanating from the red-meat and dairy industries, engulfed the committee, and Senator McGovern (who had a great many cattle ranchers among his South Dakota constituents) was forced to beat a retreat.

-The committee’s recommendations were hastily rewritten. Plain talk about food was replaced by artful compromise: “Choose meats, poultry and fish that will reduce saturated-fat intake.”

– The linguistic capitulation did nothing to rescue McGovern from his blunder; the very next election, in 1980, the beef lobby helped rusticate the three-term senator, sending an unmistakable warning to anyone who would challenge the American diet, and in particular the big chunk of animal protein sitting in the middle of its plate.

– Henceforth, government dietary guidelines would shun plain talk about whole foods, each of which has its trade association on Capitol Hill, and would instead arrive clothed in scientific euphemism and speaking of nutrients, entities that few Americans really understood but that lack powerful lobbies in Washington.

– This was precisely the tack taken by the National Academy of Sciences when it issued its landmark report on diet and cancer in 1982. Organized nutrient by nutrient in a way guaranteed to offend no food group, it codified the official new dietary language. The Age of Nutritionism had arrived.

– In the case of nutritionism, the widely shared but unexamined assumption is that the key to understanding food is indeed the nutrient. From this basic premise flow several others. Since nutrients, as compared with foods, are invisible and therefore slightly mysterious, it falls to the scientists (and to the journalists through whom the scientists speak) to explain the hidden reality of foods to us.

– Another potentially serious weakness of nutritionist ideology is that it has trouble discerning qualitative distinctions between foods. So fish, beef and chicken through the nutritionists’ lens become mere delivery systems for varying quantities of fats and proteins. Similarly, any qualitative distinctions between processed foods and whole foods disappear when your focus is on quantifying the nutrients they contain (or, more precisely, the known nutrients).

– This was a great boon for manufacturers of processed food, and it helps explain why they have been so happy to get with the nutritionism program. In the years following McGovern’s capitulation and the 1982 National Academy report, the food industry set about re-engineering thousands of popular food products to contain more of the nutrients that science and government had deemed the good ones and less of the bad, and by the late ’80s a golden era of food science was upon us.

– Following the official dietary recommendations that we cut down on saturated fat, Americans did indeed change their diets. The industrial food supply was promptly reformulated to reflect the official advice, giving us low-fat pork, low-fat Snackwell’s and all the low-fat pasta and high-fructose (yet low-fat!) corn syrup we could consume. Which turned out to be quite a lot.

-Oddly, America got really fat on its new low-fat diet — indeed, many date the current obesity and diabetes epidemic to the late 1970s, when Americans began binging on carbohydrates, ostensibly as a way to avoid the evils of fat.

-We were then told by various dietary fads that America got fat when, responding to bad scientific advice, it shifted its diet from fats to carbs, suggesting that a re-evaluation of the two nutrients is in order: fat doesn’t make you fat; carbs do. (Why this should have come as news is a mystery: as long as people have been raising animals for food, they have fattened them on carbs.)

– But there are a couple of problems with this revisionist picture. First, while it is true that Americans post-1977 did begin binging on carbs, and that fat as a percentage of total calories in the American diet declined, we never did in fact cut down on our consumption of fat. Meat consumption actually climbed. We just heaped a bunch more carbs onto our plates, obscuring perhaps, but not replacing, the expanding chunk of animal protein squatting in the center.

-How did that happen? I would submit that the ideology of nutritionism deserves as much of the blame as the carbohydrates themselves do — that and human nature. By framing dietary advice in terms of good and bad nutrients, and by burying the recommendation that we should eat less of any particular food, it was easy for the take-home message of the 1977 and 1982 dietary guidelines to be simplified as follows: Eat more low-fat foods. And that is what we did.

– Most nutritional science involves studying one nutrient at a time, an approach that even nutritionists who do it will tell you is deeply flawed. “The problem with nutrient-by-nutrient nutrition science,” points out Marion Nestle, the New York University nutritionist, “is that it takes the nutrient out of the context of food, the food out of the context of diet and the diet out of the context of lifestyle.”

– If nutritional scientists know this, why do they do it anyway? Because a nutrient bias is built into the way science is done: scientists need individual variables they can isolate. Yet even the simplest food is a hopelessly complex thing to study, a virtual wilderness of chemical compounds, many of which exist in complex and dynamic relation to one another, and all of which together are in the process of changing from one state to another.

-So if you’re a nutritional scientist, you do the only thing you can do, given the tools at your disposal: break the thing down into its component parts and study those one by one, even if that means ignoring complex interactions and contexts, as well as the fact that the whole may be more than, or just different from, the sum of its parts. This is what we mean by reductionist science.

– Scientific reductionism is an undeniably powerful tool, but it can mislead us too, especially when applied to something as complex as, on the one side, a food, and on the other, a human eater. It encourages us to take a mechanistic view of that transaction: put in this nutrient; get out that physiological result.

– People don’t eat nutrients, they eat foods, and foods can behave very differently than the nutrients they contain. That’s the great thing about eating food as compared with nutrients: you don’t need to fathom a carrot’s complexity to reap its benefits.

– Scientists make a second, related error when they study the food out of the context of the diet. We don’t eat just one thing, and when we are eating any one thing, we’re not eating another. We also eat foods in combinations and in orders that can affect how they’re absorbed..

-But we do understand some of the simplest relationships, like the zero-sum relationship: that if you eat a lot of meat you’re probably not eating a lot of vegetables. This simple fact may explain why populations that eat diets high in meat have higher rates of coronary heart disease and cancer than those that don’t. Yet nutritionism encourages us to look elsewhere for the explanation: deep within the meat itself, to the culpable nutrient, which scientists have long assumed to be the saturated fat.

– Of course thanks to the low-fat fad (inspired by the very same reductionist fat hypothesis), it is entirely possible to reduce your intake of saturated fat without significantly reducing your consumption of animal protein: just drink the low-fat milk and order the skinless chicken breast or the turkey bacon.

-So maybe the culprit nutrient in meat and dairy is the animal protein itself, as some researchers now hypothesize. (The Cornell nutritionist T. Colin Campbell argues as much in his recent book, “The China Study.”) Or, as the Harvard epidemiologist Walter C. Willett suggests, it could be the steroid hormones typically present in the milk and meat; these hormones (which occur naturally in meat and milk but are often augmented in industrial production) are known to promote certain cancers.

– But people worried about their health needn’t wait for scientists to settle this question before deciding that it might be wise to eat more plants and less meat. This is of course precisely what the McGovern committee was trying to tell us.

– The Mediterranean diet is widely believed to be one of the most healthful ways to eat, yet much of what we know about it is based on studies of people living on the island of Crete in the 1950s, who in many respects lived lives very different from our own. Yes, they ate lots of olive oil and little meat. But they also did more physical labor. They fasted regularly. They ate a lot of wild greens — weeds. And, perhaps most important, they consumed far fewer total calories than we do. Similarly, much of what we know about the health benefits of a vegetarian diet is based on studies of Seventh Day Adventists, who muddy the nutritional picture by drinking absolutely no alcohol and never smoking.

– In the end, the biggest, most ambitious and widely reported studies of diet and health leave more or less undisturbed the main features of the Western diet: lots of meat and processed foods, lots of added fat and sugar, lots of everything — except fruits, vegetables and whole grains. In keeping with the nutritionism paradigm and the limits of reductionist science, the researchers fiddle with single nutrients as best they can, but the populations they recruit and study are typical American eaters doing what typical American eaters do: trying to eat a little less of this nutrient, a little more of that, depending on the latest thinking.

– But what about the elephant in the room — the Western diet? It might be useful, in the midst of our deepening confusion about nutrition, to review what we do know about diet and health. What we know is that people who eat the way we do in America today suffer much higher rates of cancer, heart disease, diabetes and obesity than people eating more traditional diets. (Four of the 10 leading killers in America are linked to diet.) Further, we know that simply by moving to America, people from nations with low rates of these “diseases of affluence” will quickly acquire them.

-Nutritionism by and large takes the Western diet as a given, seeking to moderate its most deleterious effects by isolating the bad nutrients in it — things like fat, sugar, salt — and encouraging the public and the food industry to limit them. But after several decades of nutrient-based health advice, rates of cancer and heart disease in the U.S. have declined only slightly (mortality from heart disease is down since the ’50s, but this is mainly because of improved treatment), and rates of obesity and diabetes have soared.

-No one likes to admit that his or her best efforts at understanding and solving a problem have actually made the problem worse, but that’s exactly what has happened in the case of nutritionism.

-The case of corn points up one of the key features of the modern diet: a shift toward increasingly refined foods, especially carbohydrates. Humans have been refining grains since at least the Industrial Revolution, favouring white flour (and white rice) even at the price of lost nutrients. Refining grains extends their shelf life (precisely because it renders them less nutritious to pests) and makes them easier to digest, by removing the fibre that ordinarily slows the release of their sugars. Much industrial food production involves an extension and intensification of this practice, as food processors find ways to deliver glucose — the brain’s preferred fuel — ever more swiftly and efficiently.

-So fast food is fast in this other sense too: it is to a considerable extent predigested, in effect, and therefore more readily absorbed by the body. But while the widespread acceleration of the Western diet offers us the instant gratification of sugar, in many people (and especially those newly exposed to it) the “speediness” of this food overwhelms the insulin response and leads to Type II diabetes.

-It’s no coincidence that most of the plants we have come to rely on are grains; these crops are exceptionally efficient at transforming sunlight into macronutrients — carbs, fats and proteins. These macronutrients in turn can be profitably transformed into animal protein (by feeding them to animals) and processed foods of every description. Also, the fact that grains are durable seeds that can be stored for long periods means they can function as commodities as well as food, making these plants particularly well suited to the needs of industrial capitalism.

-The needs of the human eater are another matter. An oversupply of macronutrients, as we now have, itself represents a serious threat to our health, as evidenced by soaring rates of obesity and diabetes. But the undersupply of micronutrients may constitute a threat just as serious. Put in the simplest terms, we’re eating a lot more seeds and a lot fewer leaves, a tectonic dietary shift the full implications of which we are just beginning to glimpse. If I may borrow the nutritionist’s reductionist vocabulary for a moment, there are a host of critical micronutrients that are harder to get from a diet of refined seeds than from a diet of leaves.

– The last important change wrought by the Western diet is not, strictly speaking, ecological. But the industrialization of our food that we call the Western diet is systematically destroying traditional food cultures. Before the modern food era people relied for guidance about what to eat on their national or ethnic or regional cultures. Cultures have had a great deal to say about what and how and why and when and how much we should eat and would not have endured if they did not keep eaters alive and well.

-The sheer novelty and glamour of the Western diet, with its 17,000 new food products introduced every year, and the marketing muscle used to sell these products, has overwhelmed the force of tradition and left us where we now find ourselves: relying on science and journalism and marketing to help us decide questions about what to eat.

-It might be argued that, at this point in history, we should simply accept that fast food is our food culture. Over time, people will get used to eating this way and our health will improve. But for natural selection to help populations adapt to the Western diet, we’d have to be prepared to let those whom it sickens die.

-That’s not what we’re doing. Rather, we’re turning to the health-care industry to help us “adapt.” Medicine is learning how to keep alive the people whom the Western diet is making sick. It’s gotten good at extending the lives of people with heart disease, and now it’s working on obesity and diabetes. But while fast food may be good business for the health-care industry, surely the cost to society — estimated at more than $200 billion a year in diet-related health-care costs — is unsustainable.

Conclusions and dietary suggestion to be presented next week!

Here’s to eating whole food comprising mainly whole grains, plants, legumes, nuts and fruits!




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