Emerging markets: Are they too expensive?

Ian de Lange of Seed Investments writes that there are various views on the valuation of emerging markets. Some strategists are saying expensive, others such as Franklin Templeton, fully priced but the low interest rate environment in developed markets will continue to push capital from developed markets to emerging markets in 2010.

Canadian research house, BCA Research, founded in 1949, has a view that Emerging market stocks are no longer cheap. They say that these markets already reflect a lot of good news, leaving them vulnerable to even minor disappointments.

BCA Research : “Emerging market (EM) equity multiples have moved significantly higher in recent months, based on various valuation measures. A further multiple expansion in the developing markets would represent an overshoot of valuations from fundamentals. “

Their view is that there are 2 possible scenarios for emerging market shares.

1.            “A full-fledged mania will develop with multiples continuing to expand,”

2.            or, a setback/period of indigestion will occur before a new upleg develops.

They think that the possibility of a fully fledged mania is on the lower end of the scale because Chinese stocks would be at the epicentre and these shares have been trending sideways since July.

Their view is that at current valuations emerging market shares are increasingly vulnerable to even minor negative surprises.

The graphs presented by BCA Research give a clear indication that prices relative to historic and forward company earnings have moved up substantially from a year back.

Franklin Templeton’s Mark Mobius view is that emerging market shares are volatile by nature and while not in bubble territory, price gains from these levels “will eventually make many emerging market stocks overvalued.”

At the same time the fundamentals from many of the emerging markets will see a higher growth trajectory in the medium to long term.

Money flows can drive prices over any shorter time frame, but the valuations are important. South African equities appear to be better value than the average Emerging market, but markets are no on the cheap end of the scale.