Value Investing: Tools and Techniques for Intelligent Investment

Chapter 27. Overpaying for the Hope of Growth: The Case Against Emerging Markets^[27]

Perhaps the most persistent 'mistake' I encounter among investors is the habit of overpaying for the hope of growth. Nowhere is this behaviour currently more evident than in the context of emerging markets. Emerging markets are trading on an incredible 40× cyclically adjusted earnings! Price action within the emerging markets looks to be following the pattern established by previous bubbles. A prima facie case for a bubble exists, yet investors simply don't want to hear any of the bad news. Instead they prefer to utter those four most dangerous words in investment ... 'This time is different'. That has never yet ended well!

• Investors seem to be funnelling into any investment opportunity that offers them the hope of growth. Nowhere is this more evident than in the context of the emerging markets. I have a penchant for following the advice of Sir John Templeton, 'To buy when others are despondently selling and to sell when others are greedily buying.' So let me present a bear case on the emerging markets.

• Let us start with valuation. Emerging markets (EMs) are trading at a distinct premium to developed markets. For instance, EMs are on a trailing P/E of 22×, vs a 14 × multiple for the developed markets. Using our favoured valuation measure – the cyclically adjusted PE, emerging markets are trading on 40×! This is the same sort of valuation that developed markets reached during the dotcom madness.

• Indeed ...