Comment: Beware emerging market hype – and watch out for ‘the two Vs’ – volatility and valuations

Comment: Beware emerging market hype – and watch out for ‘the two Vs’ – volatility and valuations

Mon, 25/01/2010 - 06:00

Hype surrounding booming emerging market funds could trip up investors anxious to get a slice of the action from dynamic economies, warns Rob Pemberton (pictured), investment director of HNW wealth manager HFM Columbus.

 

2009 saw the likes of the Chinese, Indian and Brazilian stockmarkets enjoy 80 per cent rises, with Russia outgunning its rivals with 100 per cent growth over the year.
 
There is no doubt that all these economies are rapidly increasing their share of global GDP. They enjoy low debt levels, young and dynamic populations, and all host companies which are rapidly becoming world leaders. The fundamentals in these markets are predictable and positive, which may be comforting - but carries with it the danger of complacency for investors.
 
Two flies in the ointment - volatility and valuations – are worrying. Huge rises and falls are a way of life in these markets. Even after the substantial rises in 2009, most emerging market stockmarkets are below where they were at the beginning of 2008 because of the market carnage that year.
 
These markets remain closely correlated to the US stock market – so any correction on Wall Street will likely to be felt in greater magnitude in these markets. The economies may be increasingly ‘de-coupled’ but the same cannot be said for the global stock markets, a point often overlooked by the emerging market cheerleaders.
 
So what should the emerging market investor consider first and foremost? Look beyond the level of economic and corporate profit growth – examine the price you are paying for it.
 
Historically emerging markets used to trade at a discount to developed markets due to their record of instability but this is no longer the case and emerging markets are starting to look dangerously pricey.
 
China and Brazil trade on around 14x earnings, in line with developed markets, and India a pretty rich 18x. The only significant emerging market with a P/E of less than 10 is Russia.
 
Advocates of emerging markets argue that a P/E premium is warranted because of the growth potential – but our view is that political and corporate risk is still much higher than in the developed world.
 
Were book values to rise above current level of 2x and P/E ratios hike up to around 18x then investors should assume they are in dreaded ‘bubble’ territory and be fearful of an imminent and painful correction.
 
Emerging markets are still a good option for the long haul, but tactically investors are advised to wait for a pull-back before committing new money.

 


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