I have money in VEIEX - VANGUARD EMERGING MARKETS STOCK. I recently read an article in which the 'expert' antcipated the run that international emerging funds has had over the last couple of years to end. He seemed to consider it a bubble. This goes against the notion that i've had in my readings that China and India still have massive untapped markets. What indicators should I keep my eye on in regards to when to sell my holdings in that fund - the dollar's strength overseas? maybe trends in other key international funds?
Obviously, I am sure there are other 'experts' that would contend that the fund is likely to continue it's gains a bit longer, but I want to educate myself in possible international indicators.
The bubble argument is a strong one. The PEs of stocks in India and China are eye watering, and there is massive local speculation.
The basic indicator is that when the market starts to fall, the bubble may be deflating. Emerging market bonds (the yield spread over US Treasuries) may also be interesting in this regard (meaningless I suspect in the case of China and Russia, but interesting in the case of India and other markets).
More generally, keep an eye on the Yen: the fuel for the world's speculative markets is the 'yen carry trade' ie borrowing in Yen and investing elsewhere. So if the Yen starts to rise against the dollar and the euro and/or the Bank of Japan raises interest rates, then that situation starts to unwind.
The price of risky assets all over the world will start to rise relative to 'safe' assets. This former includes property, high yield bonds and emerging market equities.
People who can predict the timing of such things either don't exist, or are very, very rich. Neither is likely to post here ;-).
You may wish to take a look at the data first. These are the valuation indicators for emerging markets as of end-2006:
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Looking at the average price-to-book value ratios (P/B) which is the main indicator of how expensive a market is (high P/Bs usually imply an overvalued markets), Argentina, Egypt, India, Mexico, Morocco, and Nigeria have higher average P/Bs than the U.S. In particular, Egypt, India and Nigeria were clearly overvalued (P/Bs above 4, versus an average P/B of 3.05 for the US market). By contrast, Colombia, Thailand, Turkey and Venezuela have all P/Bs below 2. In all these cases, however, the low valuation comes at an expense of high risks, in particular political risks, which in Thailand or Venezuela -Chavez effect- are particularly high.
A relatively attractive market with less political risk is South Korea's (a P/B of just 1.65). This is probably why Warren Buffett has already started investing in this market. (the big risk in South Korea is, of course, North Korean nukes).
In my opinion, an allocation of about 15 percent of your portfolio to CAREFULLY chosen emerging markets makes perfect sense. If you are not too worried about the potential risk of North Korean nukes on South Korea or you think that Thailand's recent political problems are not going to weigh too much in its stock market, these are probably the two markets you should select for your emerging markets allocation.
One problem with looking at these metrics in emerging markets is that many of these countries lack even basic accounting standards at the business level, or standards for reporting those figures at the exchange level. It's nothing at all like the US. It's been reported quite a bit for China, which is beginning to adopt Western-style standards -- and revealing some shaky foundations.
I've seen posts recently here with what look to me like very high allocations to these markets, especially some that have run up a great deal the past few years. I think it's worth looking at the market capitalization (total value of traded shares) of these markets to put them in perspective. For quite a few of them, you're talking about an entire stock market with a market cap lower than many individual US corporations. (grabs Economist Pocket World in Figures 2006...) With the run-up these figures may be higher now but consider these 2003 numbers:
Thailand $119B - less than half the size of Citibank Turkey $68B - a bit smaller than Apple Egypt $27B - a bit larger than Starbuck's or Best Buy Morocco $13B - a bit under Bed Bath & Beyond. For the whole market!
Oh and a few developed markets... UK $2,412B Japan $3,040B US $14,266B
The notion of buying into a stock market whose entire market cap is that of a mid-sized US company raises some questions about liquidity; these are sort of the penny stocks of equity markets. Caveat emptor!
As you imply, the *composition* of the index has a huge effect. For example, banks and resource companies tend to trade at low P/B. The UK has a very heavy weighting in financial. 4 sectors: pharma, banks, oil and gas, mining account for something like 60% of the FTSE100 (although most funds index to the All-Share, which is somewhat broader). 2 oil companies are 16% of the index (Shell and BP).
The biggest Mexican stock (by far) was Telefonos de Mexico, a company which makes its money on the basis of its domination of Mexican politics (which blocks new entrants into the telecoms sector, Mexico has some of the world's highest phone rates).
I remember looking at an emerging markets ETF and concluding that it was essentially a bet on Korean and Taiwanese tech companies.
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36% in Korean and Taiwanese stocks at the end of '05.
It feels as if there is a real rush into emerging markets now.
I now have a good explanation of why risk is underpriced out there, the product of an article by Gillian Tett of the Financial Times, and a letter from Pimco published in the same issue.
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Basically the story runs:
- everyone is borrowing in Japan, and investing in higher return assets (the carry trade)
- they are hedging their exposure to a rise in Japanese currency, using options. They can do this cheaply, because the Central Banks, amongst others, are *selling* currency volatility, as an option strategy.
So volatility is cheap, because there are structural players out there selling it.
I agree. South Korea and Thailand are relatively good in this area though. Both countries had IMF programs in the late 1990s, and one of the main conditions of their programs was to improve financial and stock market transparency and their accounting standards. They received plenty of technical assistance from the IMF and the World Bank these days, and most recommendations were implemented (I have some first-hand knowledge of this because I was working at the IMF at that time).
I agree again. Some of these markets present good investment opportunities though, albeit at the cost of a higher risk. That's similar to what happens with the investment in small caps: they are less liquid, but some of them -small cap value stocks- have greater long term returns than other stocks, at the cost of a higher risk.
Interesting article on emerging stock markets here. It mentions China and India as expensive markets -especially, India- and South Korea, Thailand and Malaysia as relatively cheap markets:
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