Emerging Markets Walk a Fine Line

Does the difference between a bull market and a bubble walk a razor’s edge…or a five-lane freeway? The difference may simply be a matter of perspective. If you’re long, it’s a bull market; if you’re short, it’s a bubble.

Back in the late 1990s, die-hard value investors like Jean-Marie Eveillard, Barton Biggs and Jeremy Grantham shunned the high-flying tech stock sector as a “bubble.” This “mania” would end in tears, these insightful investors predicted.

But for an uncomfortably lengthy period of time, the tech stock mania produced only smiles and riches. Eveillard, Biggs and Grantham had more reason to shed tears than their tech-stock-buying counterparts. Clients fled from both Eveillard and Grantham, while Biggs gained a reputation as a crotchety, has-been strategist.

Eveillard famously defended his caution by declaring, “I would rather lose half my clients than half my clients’ money.” And he did…lose half his clients, that is.

As the new millennium dawned, however, the tech stock bull market began to look increasingly bubblish…and Messrs. Eveillard, Biggs and Grantham began to look increasingly brilliant. In fact, they were dead-on correct. And since Eveillard and Grantham did not buy into the tech stock hype, they successfully avoided the tech stock bust. They stuck to their convictions – buying good stocks at good prices…or not at all – and compiled superior investment results for their clients.

Fast-forward ten years; Eveillard has retired. But Biggs and Grantham are still in the game. The tech stock bubble is long gone, but bull-market/bubbles are still very much with us. Depending on one’s point of view – i.e., whether one is long or short – Treasury bonds, gold and emerging market stocks are all in robust bull markets…or dangerous bubbles.

But this time around, Biggs and Grantham are taking a different approach. Bubbles are a great place to make money, they say, as long as you don’t hang around too long. “We’re only halfway along the way to a gigantic eventual bubble in the emerging markets,” says Biggs, “The emerging markets, particularly Asia, are a place where I want to have a really major representation.”

“Biggs’s view is shared by Jeremy Grantham,” Bloomberg News reports. “The chief strategist at Grantham Mayo Van Otterloo & Co. wrote on Oct. 26 that his forecast for an ‘emerging emerging bubble’ was in ‘splendid shape’ after the MSCI Emerging Markets Index soared 146 percent in the past two years.”

The nearby chart corroborates that assessment. Emerging Market stocks have never been more expensive than they are today, relative to stocks in the Developed Markets. Twelve years ago, the MSCI Emerging Market Index traded for only one fifth of the valuation of the S&P 500 Index and the MSCI World Index, based on price-to-book ratios. Today, however, the Emerging Markets are trading on parity with Developed World stocks.

Emerging Market Index vs. World Index

This surprising data point does not necessarily mean that Emerging Market stocks are overpriced or bubble-ish, but it does mean that they are no longer cheap. “Everyone and his dog are now overweight emerging [market] equities,” Grantham observes, “and most stated intentions are to go higher and higher.”

Despite these bubble-like conditions, Grantham believes Emerging Market stocks will continue running for a while longer. He recommends a “moderately overweight” position.

“The headache posed by bubbles depends on the asset managers’ perspective,” writes Dylan Grice, a global strategist at Société Générale. “For skeptics the pain is on the way up, for true believers it’s on the way down.”


Your editors here at The Daily Reckoning may be true believers, but they are not delusional. Your editors are fans of selective Emerging Markets like Brazil and India. But the current near-mania for Emerging Market stocks is probably not presenting the very best long-term investment opportunity. So keep some powder dry and don’t forget to pull the trigger the next time these markets are tanking.

Eric Fry
for The Daily Reckoning