Every once in a while, an investor with fresh money to invest should pause and ask an important question: “What asset class can I buy that is unquestionably cheap?”
All asset classes move in cycles.
Unfortunately, most investors don’t give a hoot about the assets that are out of favor. They imagine that whatever is down is likely to stay down.
And sometimes those assets do. But not forever.[ad#Google Adsense 336×280-IA]Just as every dog has its day, every asset class has its bull market.
So when you find one that is unquestionably cheap, you need only buy… and show a little patience.
What asset class is on the bargain-basement table today? Emerging markets.
Hard to believe, but you can buy most emerging market stocks today at lower valuations than they reached during the 2008-2009 financial crisis.
If you’re kicking yourself about not buying back then – or not buying enough – here is your chance at redemption.
Even after the recent sell-off in the market, U.S. stocks are trading at roughly 17 times trailing earnings. The average emerging market stock sells for just 10 times trailing earnings.
Put another way, U.S. equities are 70% more expensive than emerging market equities.
Yet mutual fund cash flow figures show that American investors are dumping emerging market stocks en masse, not buying them. They are making the classic mistake, selling what’s cheap to buy what’s expensive.
Why are they selling? One reason is that emerging markets have been poor performers. The iShares MSCI Emerging Markets ETF (NYSE: EEM) is down over the one-, two- and five-year periods… as well as down 13% year-to-date.
Now that these assets are breathtakingly cheap, investors have had enough. (Sound familiar?)
Why have emerging markets fallen? For several reasons. One is that many of them are commodity-oriented. As the prices of natural resources have fallen, so have these countries’ economic prospects.
China’s slowdown is another factor. As the world’s great manufacturing engine, that country is a huge buyer of exports from emerging markets. So when China sneezes, these countries can get the flu.
But – understand – these factors are fully priced into emerging markets. No one is going to sell emerging markets tomorrow because of China’s slowing growth.
And there are reasons for optimism.
A lot of these larger economies – especially Brazil and India – are now relying on local customers rather than exports alone for growth.
Some other emerging markets actually benefit from sharply lower commodity prices. Manufacturers in South Korea and Taiwan, for example, import a lot of raw materials.
Emerging markets are now safer in many ways too. The banks are far better capitalized than they were in the 1990s. Most major emerging market economies have floating, not fixed, exchange rates now. And more of their debt is denominated in local currency. This helps insulate them from a strong dollar.
Emerging markets offer investors three big benefits:
- Demographics. Emerging markets contain three-quarters of the world’s land mass and nearly 85% of the people. China and India alone make up nearly a third of the world’s population.
- Stronger growth rates. If you were a businessman, where would you rather operate? In an economy growing at 2% a year or in one growing three times as fast?
- Diversification. Emerging markets do not move in lockstep with developed markets. When our markets zig, theirs often zag. That means your portfolio can generate higher returns with less volatility, the whole point of diversification.
The Oxford Club recommends that investors hold 10% of their portfolio in emerging markets stocks. Yet most own little of these assets – or none at all.
Given the current cheap valuations, now would be a good time to remedy that.
Source: Investment U