Are Emerging Markets Cheap?

Investing for your pension means taking a long term view more suited to riskier assets. So is now a good entry point for emerging market equities?

Patricia Oey 13 March, 2014 | 9:54AM
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Emerging-markets stocks are typically viewed as an asset class offering the potential for higher, albeit volatile, returns, and as a source of diversification. While these traits may still generally hold, this asset class has evolved significantly over its relatively short life span, so any analysis of current valuations of emerging markets should be viewed in this context.

Like any asset class, the long-term performance of emerging-markets stocks is driven by current valuations. At this time, the most common barometer of developing markets' stocks, the MSCI Emerging Markets Index, is trading at a trailing P/E ratio of 12, below its 18-year average of 16. Its discount relative to the MSCI USA Index, which is currently trading at 19 times, is also near eight-year highs. Current valuations would seem to suggest that emerging-markets equities are poised for strong absolute and relative performance over the next decade. However, a closer examination of the history of the emerging-markets asset class suggests that they may not be cheap after all.

Emerging Markets: A History

Emerging-markets stocks, as an investable asset class, are only about 25 years old. The first emerging-markets funds available to U.S. investors had their inception in the mid-1980s, and the MSCI Emerging Markets Index launched in 1988. At its inception, the MSCI Index included 10 countries, with Malaysia, Brazil, and Chile representing its three largest country constituents. Current heavyweights such as China, Taiwan, and South Korea were not added until 1996.

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Patricia Oey  Patricia Oey is an ETF analyst at Morningstar.

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