Despite the gloom and doom about the US economy and its currency, the US stock market is faring relatively better (down 19% from its previous peak) compared to other markets. The MSCI EAFE Index which tracks stock markets in other developed markets in Europe and Japan is down 30.5% off its recent peak in U.S. dollar terms. Emerging markets measured by the MSCI Emerging Markets Index have taken a similar tumble by falling 29%.

Valuations are compelling — according to Vanguard, the current P/E ratio for VWO (Vanguard Emerging Markets ETF) is 12.24 and even lower for VEA (Vanguard Europe Pacific ETF). By contrast, the P/E ratio for the US market is 17 and 10-year Canada bonds are yielding 4.25%.

After red-hot returns for years, emerging markets are starting to look attractive. But these stocks are so volatile that a 30% drop might be just a warm up act. Due to the relatively low weighting to these stocks in the world capital markets, despite the volatility, this might be not be a bad time to get market weight exposure (5% in the Sleepy Portfolio) to this asset class or at least place it in a watch list.

This article has 5 comments

  1. We’re currently at 5% VWO but our asset allocation aims for 8% emerging markets. We’ve been purchasing VWO regularly over the past year or so and our return on it is -18% so far. 🙁

    We’re still buying to build up to 8% so it’s a relief to read your (valued) opinion that it’s looking fairly cheap right now.

  2. Canadian Capitalist

    telly: I’ve added VWO personally – at 5%, I have the target allocation now – but these markets are extremely volatile and could drop further from here. It’s impossible to time the entry but I think if we buy at reasonable valuations, we should be okay.

  3. CC,

    According to Yahoo finance the P/E on SPY or IVV ( ETF’s tracking the S&P 500) is about 13 to 13.5. If you check S&P website however the P/E on S&P 500 comes out to 24. ( 12 month EPs as of 6/30/08 is $51/share).

    Anyways aside from this, I am not very bullish on emerging markets as historically they have underperformed during a recession. That being said, many folks believe that the so called emerging markets have turned around and are somewhat immune to the US economic cycle downturns.

    My opinion however is that most emerging markets have risen as a result of the rising commodity prices, which helped them generate more in foreign currency revenues. If commodity prices were to start going south, most emerging markets will start going down faster.

  4. Canadian Capitalist

    DGI: It depends on how “earnings” are calculated. Excluding special factors such as write downs S&P’s estimate of 2007 earnings is $82.54 and $80.79 for 2008 (Standard & Poor’s The Outlook, August 20, 2008). That would put the trailing P/E at 15. Granted, completely ignoring write downs might not be entirely accurate either but that’s a smaller error than assuming one time events forever in the future.

    Note that I’m talking about broad emerging markets in this post. Among the top eight emerging markets in VWO, only two Brazil and Russia (making up 20%) are commodity based. I don’t have an opinion (even if I did, it would be worthless) on what emerging markets will do in the future. But, I know that I have a 5% target and I have to allocate that at some point of time and now doesn’t seem to be too bad from a valuation perspective.

  5. CC,

    That’s a good answer – no matter what happens you will stick to your plan.

    That’s what most investors should do.