"A hidden connection is stronger than an obvious one."
- Heraclitus of Ephesus
- Heraclitus of Ephesus
There has been much talk lately about emerging market equities. Are they overvalued or not? Is a P/E of 14 or 15 too low because of the (potential) growth rate of earnings? Or is the P/E too high because it is now similar to more developed markets and does not provide adequate compensation for the additional risks of emerging markets? Or are emerging markets currently fairly valued?
I confess I don't know the answer to that question.
But let me shift the focus to a related question. Regardless of your opinion of the current valuation, it cannot be denied that (in hindsight) 4 or 5 years ago, emerging market indexes were very undervalued. Now someone might counter that the only reason for the recent stellar returns is that emerging markets have risen way too far and are in a bubble. Hence, the argument would be that perhaps emerging markets were simply fairly valued in 2003 and are overvalued now.
Mathematically, however, this argument does not ring true. Suppose we concede that emerging markets are currently grossly overvalued and we peg "fair value" at half the current price. This would put the current P/E at about 7. While some may argue that such a P/E ratio would be appropriate to discount risks, I seriously doubt that many would claim such markets would definitely be overvalued at that level. So for sake of argument, let's say fair value is one half the current price. Even if emerging market equity indexes were currently 50% less, the appreciation during the last 4 1/2 years would still have been more that 20% annualized.
So it seems to be the case that in the Spring of 2003, emerging markets were quite undervalued, yet there was little recognition of that. The recent returns have been staggering. The total return of the Vanguard Emerging Markets Stock Index Fund from 2003 Q2 to present exceeds 350%, or more than 40% annualized over the past 4 1/2 years.
I tried to search the web for articles and analysis of emerging markets in 2002 and 2003. (The web is probably not the best medium for findings historical articles. A trip to the library to examine the archives for Barron's and Business Week would probably yield better results.) From what little information I've uncovered and pieced together, I don't really find that the attitude about emerging markets was all doom and gloom back then. Rather, it appears that emerging markets were simply totally off the radar screen for most people - unnoticed rather than unloved.
So the example of emerging markets five years ago prompts the question: What asset class is unnoticed and undervalued now? If such an asset currently exists, it's very likely that it's NOT being heavily written about in your newspaper and discussed on the web.