I had a busy start to the New Year, catching up with several clients and investors around the world. We discussed some interesting topics that I’d like to share with you here.
Emerging Markets Valuations
Many investors are now concerned about the ‘high’ price/earnings (P/E) ratios in emerging markets given the rally last year. I agree that the P/Es have risen but I think that they have done so from a very low base. We have seen market increases of 80-100% or more from the bottom in many of these markets, but I still don’t think valuations are excessive. Over the years, we have discovered that one of the best single indicators of value is the price-to-book value (P/BV). If you look at average valuations over the last ten years, you will see that the low point was about one time P/BV and at the high was about three times P/BV. We are now about two times P/BV. So in terms of the historical valuations, we appear to be in the middle of the range – not excessive, but not as cheap as we were before. Hence, we are a bit cautious on valuations in some regions like Greater China as well as in general for the emerging market universe.
Nevertheless, on a relative basis, emerging market economies seem to have done much better than those in the developed world. I believe the kind of premium that the market is currently placing on these emerging market valuations is justified, to some extent. Unless there is certain monetary tightening in these emerging market economies, I think current valuation levels are sustainable. We have to bear in mind that most emerging economies are generally much better off than developed economies in terms of earnings growth expectations.
News from Venezuela and Argentina
Investors were also concerned about the negative news coming out of Venezuela and Argentina recently. We do not have direct holdings in Venezuela and hence, we do not believe that we are really affected by the recent currency devaluation. In our view, the surest sign of the instability of a currency is the existence of a thriving black market. On January 8, the black market rate of the Bolivar was about 6.25 per US dollar, while the previous official rate was 2.15 and the new rate was 4.30. We believe that only when the street rate and the official rate are one and the same can a country’s currency be considered even remotely healthy.
As for Argentina, the companies that we invest in tend to be more multi-national, with operations in other parts of the world. Hence, these companies are not as exposed to the Argentinean economy. We think that these types of companies continue to be attractive, particularly if prices decrease.
Clarification on Market Correction
Many of you have quoted from recent media reports that I had predicted a 20% correction in emerging markets. To clarify, what I said was that in a bull market as we are now experiencing, there will be corrections as the market continues to march upwards, and such corrections could be anywhere from 15 to 20%, or even 30%. We have to be ready for such short-term volatility. The markets in China, Asia, and Dubai have seen corrections of 20% or more during the recent crisis, so these kinds of corrections should not be surprising.I want to emphasize that I am not predicting any specific correction but I am just saying that we have to prepare for such corrections and that we not be alarmed by them given current market conditions. Overall, I believe we will continue to see markets rise in the long run.
Emerging markets have rallied over the past year and investors might be tempted to take profits, which in my view could lead to short-term market corrections. That said, we expect these kinds of corrections in emerging markets and rather than focusing on when a correction might happen, we focus on picking up investments that in our view have dropped to compelling valuations as a result.
The long-term outlook for emerging markets remains positive, as I discussed at greater length in my previous blog post.
 Source: MSCI and Factset, as of Dec 2009.