Issue 47 • OCTOBER 14, 2009 Investing in Global Stocks? Emerging Markets May Offer Best Rewards
In 2008, the MSCI Emerging Market Index got taken to the woodshed, sinking -53% in value. But so far this year, these markets have soared +64% in value ... and are up a whopping +91% since the global market low in March.1 Emerging markets are clearly leading the charge ... and by a very wide margin. After such big gains, some investors are naturally beginning to wonder whether emerging markets are getting ahead of themselves — if not moving into outright overvalued territory. The good news is that emerging market stocks ... UNLIKE the S&P 500 Index, for example ... DO NOT appear overvalued — yet. In fact, based on long-term measures, emerging market equities still look somewhat under-priced ... even after a +91% rebound off the bottom! The jury is still out on the question of a robust global recovery, which is an important prerequisite to strong profit growth in export-dependent emerging nations. However, even here, the prospects look brighter abroad than they do here at home ... let’s do the math! First, valuation: The most common valuation metric is the price-to-earnings (P/E) ratio. Emerging market stocks, as represented by the MSCI Emerging Market index, has a current P/E of about 16 based on trailing 12-month earnings. This is below the long-term average P/E of 16.5 for emerging markets ... not a very big discount perhaps, but it’s still a DISCOUNT.2 The S&P 500, by contrast, sports a rich P/E of 27.6 times trailing earnings. This is based on operating earnings ... in other words ... earnings without all the bad stuff! Today’s P/E ratio is pretty far out of whack with the historical average of about 16 times trailing earnings for the S&P … But wait, it gets even worse.3 Analysts tend to throw out the “bad stuff” when calculating earnings, which means one-time losses and other non-operating charges are excluded. That’s because some analysts view these as non-recurring losses that can distort the true profit picture.
Strangely enough, during boom times for the economy, you don’t hear much about analysts throwing out one-time gains from corporate earnings! Anyway, if you include all the actual losses being taken by corporate America these days (mostly from the financial sector), then today’s S&P 500 P/E ratio on reported earnings is an astronomical 140 — the highest level in recorded history!4 Going back 60 years ... and digging through more than 700 months of market data ... there have only been 14 months (less than 2% of the time) over the past 60 years when the trailing P/E multiple was as high as it is today. Put another way: Stocks have been cheaper than they are now about 98% of the time.5 Granted, we’ve come through a devastating period for corporate profits due to last year’s financial meltdown — the worst since the Great Depression. And aftershocks will be felt for some time I’m afraid. Yet, there’s a case to be made — mostly by the bulls — that S&P 500 earnings are unusually depressed right now ... which skews the traditional trailing P/E ratio. Some economists, including Robert Shiller (Irrational Exuberance) and Benjamin Graham (Security Analysis, The Intelligent Investor), calculate the market’s P/E ratio based on “normalized” earnings ... or several years worth of average earnings, rather than a single, trailing 12-month period. This helps smooth out unusual peaks and valleys in the earnings cycle, providing a clearer picture of the underlying trend in profits. For the S&P 500, looking at the P/E ratio based on the past five years of reported earnings (including full year 2009 estimates) reveals a valuation of about 20-times earnings for U.S. stocks. Again, that’s still expensive from a historical perspective.
Emerging market stocks have a current P/E (based on trailing 12-month profits) of just 16.2 ... significantly less expensive than the 27.6 P/E ratio of the S&P 500.6 What’s more, based on the normalized five year earnings trend ... emerging markets look even cheaper, with a P/E of just 13.6 compared to nearly 20 for U.S. stocks!7 In fact, the normalized P/E of 13.6 for emerging market stocks today is one of the cheapest readings in the past six years (See graph above), signaling that shares in developing markets are perhaps a much better bargain now than in developed markets like the U.S. And that’s not all ... prospects for the future look much brighter in emerging markets too.
In fact, consumer spending in China is expected to grow by about 10% in 2010, and Brazil is forecast up about 4%, while spending in the U.S. remains flat.8 Emerging markets could experience even faster earnings growth as the global economy recovers too. Emerging market firms are expected to book profit growth of nearly +20% next year, while earnings in the U.S. and Europe expand less than +12% ... or about half as much (See graph below).9 So, emerging markets offer investors two opportunities: First, less expensive valuation; and second, better long run growth prospects compared to developed markets. This could easily translate into higher total return potential going forward.
To be sure, there are still a number of caveats to consider before you jump headlong into emerging market shares. First, there is the 91% rocket ride to the upside these markets have enjoyed since March of this year. It has been a nearly uninterrupted move, and so it wouldn’t be surprising for a correction of 15% to 20% to unfold at some point. Second, although the economic data out from China, India and Brazil, among other emerging nations, has been quite upbeat recently, I’m still concerned about the dramatic decline in export growth. In spite of an ongoing shift toward more consumer demand internally, these nations are still highly dependent on exports for economic growth. Take Asia for example: Emerging market exports — mainly to the U.S. and Europe — have fallen about -20% year-over-year, according to recent data. Although that is an improvement from earlier this year when exports were down -30% annually. India’s exports fell -19.4% in August, which is slightly less-bad than July’s -28.4% reading.10 However, it’s also interesting to note that even with such big export declines, both China and India are still seeing positive GDP growth readings. Bottom line: While there’s still some uncertainty in emerging market economies, they appear to be recovering much faster and stronger than the U.S. The Weiss Capital investment team keeps a very close eye on the incoming data from around the globe, since many of our investment strategies include international fund holdings. And since the best growth AND valuations may be found today in select emerging markets ... far beyond the S&P 500 ... I’ll be closely watching the export data for signs of further improvement. Good investing!
1 FMRCo (MARE): Emerging-Market Stocks: Valuations Still Reasonable, 9/28/09 Disclaimers: 1. Weiss Advice is a publication of Weiss Capital Management, an SEC Registered Investment Adviser. Weiss Research is a separate, but affiliated publishing company. Both entities are owned by Weiss Group, LLC. 2. "Weiss Advice" is published for general information and educational purposes only and should not be construed as a specific recommendation to buy or sell any security. Specific recommendations can only be given to advisory clients of Weiss Capital Management, with the benefit of knowing their financial condition and suitability. Receipt of this publication should not be construed as a solicitation to do business outside the jurisdiction for which the Firm is approved. Currently, Weiss Capital Management offers investment advisory services to individuals maintaining legal residency within the United States. For details, please contact the Firm. View Weiss Capital Management's Privacy Policy. To make sure you don't miss our urgent updates, add Weiss Advice to your address book. Just follow these simple steps. |
In a past issue of Weiss Advice (
By contrast, emerging markets, offer a more attractive valuation picture when compared to the S&P 500 Index. 
Goldman Sachs estimates that consumer spending growth in emerging market countries may outpace the U.S. and other developed markets by a very wide margin over the next two years. 
