Wednesday, March 01, 2006

Emerging Markets: Bubble? Or Value?

There's been some discussion lately that emerging markets are entering potential bubble territory, due to magnificent gains of 56% in 2003, 26% in 2004 and 34% in 2005, for the iShares MSCI Emerging Markets ETF (Symbol: EEM). This can get an investor worrying about whether or not they are buying into a bubble if they are considering purchasing an emerging market ETF.

Surprisingly, even after the recent strong gains, the answer seems to be "No". According to research from State Street Global Advisors, they state that in January 2003 the MSCI Emerging Markets Index held the following value metrics:
  • PE Ratio - 14
  • Price to Book Ratio - 1.4
  • Price to Cash Flow Ratio - 9
  • Dividend Yield - 2.4%
By comparison, in January 2006, the same metrics were as follows:
  • PE Ratio - 15
  • Price to Book Ratio - 2.4
  • Price to Cash Flow Ratio - 8
  • Dividend Yield - 2.5%

The reader can see that the only metric undergoing significant change is the price to book ratio, perhaps a sign that these economies are undergoing the first vestiges of an industrialized country valuation metrics. By comparison, the S&P500 trades at:

  • PE Ratio - 15
  • Price to Book Ratio - 2.4
  • Price to Cash Flow Ratio - 11
  • Dividend Yield - 1.9%

While one can argue that emerging markets have particular risks all their own, these are generally diminishing, while the US market is obviously overhung by the gigantic trade and fiscal deficits, and are thus more risky than they were a dozen years ago.

A summary comment relating to the emerging markets issues was as follows:

"Valuations make it more difficult to argue for dramatic outperformance of emerging markets, but otherwise the fundamentals still look reasonably good. With good global growth and continued low interest rates, there appears to be little to derail emerging markets other than the psychological burden of three good years of performance"
  • Brad Ahram, head of emerging markets, State Street Global Advisors

So, emerging markets still look like reasonable value to this observer(given their better estimated earnings growth over the next year or so), but I would suggest either buying a wide swath ETF, or watching what particular countries you select in your ETF basket. I personally like Brazil, Russia and South Korea as being reasonably priced with good growth prospects.


The Confused Capitalist

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