Superbowl Follow Up

During the Q&A of the emerging markets panel I sat on at the Superbowl of Indexing an audience member asked a reasonably skeptical question about the valuations of emerging markets. He noted that PE ratios are now generally in the mid teens and he wondered why the panel wasn't more skeptical or maybe more guarded in our outlooks.

While I would note that the context of the panel was long term fundamentals there was not much in the way of caution other than my talking about small weightings to each country. Part of my reply to this question was to note that PE ratios for emerging market stocks used to be in the mid to high single digits and I stressed that this was important for anyone investing here to understand.

After thinking about this some more I think there is a more productive way to address the issue. First, the person asked about emerging market PE ratios. This frames the issue as if all emerging markets are the same thing which of course they are not--early on on the panel I said I thought the term emerging markets is useless and talked a little about looking a the story on the ground, the things to look at in terms of economic stats and demographics.

I'll repeat that the term emerging market has lost most or all of its meaning. Many of the emerging markets had their debt crises years ago and are now far less indebted than the developed markets--in many instances. Every investment destination on the planet has attributes, positives and negatives. This includes stories on the ground, valuations and everything else. There is also the dynamic of how each country, depending on how it is accessed, interacts with the other countries and how they are accessed in the portfolio.

The nature of the current event has been to punish countries with the largest debt problems. As "the worst crisis in 80 years" it stands to last a while longer. If you agree with that line of thinking then it makes sense to avoid or underweight the countries that have the largest debt problems. Taking the largest debtors off the table leaves plenty of destinations with all sorts of attributes to choose from and while plenty of them are emerging or frontier I would say in this context a country being healthier debt-wise is more important than the label of emerging or developed.

From there anyone buying at the country level then needs to analyze each country on the totality of its merits. Someone who places a high priority on PE ratios would not buy something with a high PE ratio. Of course even if a country has a high PE ratio there will be stocks in that market with low PE ratios. The decision to buy or avoid should boil down to how you weigh the various attributes that comprise the story. Long time readers will know I've gone back and forth a few times with China being in, then out, in again, out again and now in but underweight via a couple of thematic (not China specific) ETFs. Decisions along these lines cannot always be correct of course but a reasonable process for country selection is possible for people inclined to put the time in.

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