That’s because last year, when U.S. stocks went on a tear advancing by some 32 percent, emerging-market stocks headed in the opposite direction. Many investors lost patience as they pulled more than $15 billion from emerging-market exchange-traded funds in the three months through January of this year, according to the Lipper unit of Thomson Reuters Corp.
Then, just after many investors abandoned their developing-world investments, emerging-market stocks turned around, with the MSCI Emerging Markets Index gaining 15.7 percent from the beginning of February through July 31, compared with a 9.4 percent gain for the S&P 500.
|The fundamental advantages of emerging markets, particularly in Asia, remain solidly in place.|
But don’t worry if you missed out on that rally because I believe this is still a good time to invest in emerging-markets stocks. Valuations of emerging-markets companies remain cheap compared with those of stocks in the U.S. and other developed markets, and growth forecasts are higher for emerging economies.
Emerging-market stocks often trade at lower valuations than those in developed markets, but the size of the current spread is unusual as shown in the chart below.
What’s more, the ratio of market capitalization to gross domestic product — a long-term valuation measure popularized by Warren Buffett — was recently reported by the Wall Street Journal to be 0.37 for emerging markets compared with 1.19 for the U.S.
Over time, that gap will close, and that’s how you’ll really get the good performance over the long term.
Does that mean it’s time for investors seeking long-term value to look outside the U.S.?
With the U.S. economy expected to grow 2 percent a year and the U.K. at 1.5 percent, compared with China expanding at 7.5 percent and India at 5 percent, it may be time to look elsewhere.
Investors who ignore what drives emerging markets risk missing out over the long run.
That’s because the fundamental advantages of emerging markets, particularly in Asia, remain solidly in place, including:
- A strong banking system supported by high personal savings rates. Most banks have avoided foolish lending practices and are in a much stronger position to finance economic growth than peers in the developed world.
- Ample foreign-currency reserves with flexible exchange-rate policies.
- Companies with healthy balance sheets.
- Strong growth fundamentals — fast-growing, increasingly richer, middle classes; continuing strong investment in infrastructure that promotes economic growth; generally business-friendly government economic policies.
With forward-looking price-to-earnings ratios for emerging markets now well below their long-term averages when compared to the U.S. market, shares of companies in the emerging world have rarely been so cheap.
As the iconic investor Warren Buffett says: “Price is what you pay, value is what you get.”
Along that line, that’s why I believe the emerging markets have fallen back toward levels that represent good value. While they could lag in the short run, especially if their currencies weaken, it’s my view that patient investors who maintain a balanced portfolio will be well-rewarded.
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