Emerging Markets Stocks: An Overvalued Asset Class?

Includes: EEM, SPY
by: J.D. Steinhilber

The following was excerpted from Agile Investments' special report on emerging markets stocks:

Prior to the bull run of the past five years, the price-to-earnings (P/E) multiple of emerging markets stocks historically averaged approximately 75% of the P/E multiple of developed markets stocks (including the U.S.), and the price-to-book multiple averaged 67% that of developed markets. Over this period (1985-2002), whenever emerging markets valuations moved to parity or to a premium to developed markets valuations, it was a signal to reduce exposure or avoid the asset class. The traditional attitude towards emerging markets stocks was that they warranted a discounted valuation because of their greater risk characteristics, their dependence on export activity rather than domestic demand, and their propensity to suffer political and economic crises.

Today, emerging markets stocks are valued at a significant premium to foreign developed markets stocks and a modest discount to U.S. stocks (see Exhibit 2). The current 20x P/E multiple of the S&P 500 is somewhat misleading because of the heavy write downs that U.S. financial firms have taken in recent quarters. On the basis of calendar 2008 estimated earnings, the P/E multiples of the S&P 500 and the emerging markets index are much closer, at 15.7x, and 13.9x, respectively.