ChartBrief 183 – EM Equity Valuations

Emerging Market Equities have seen an incredible run since the 2016 bottom (not to make a song and dance about it, but that was about when I turned bullish on EM equities, just saying…). To throw a few statistics and data-points around: the MSCI EM Index is up 85% since the bottom in January 2016 (66% in local currency terms), in 2017 alone it was up 34% in USD terms (vs 19% for the S&P500), and already in 2018 YTD it’s up 10%. Looking at EM ETF assets under management, there has been a $121B increase (to more than $180B total), which amounts to a 204% gain, vs the 85% performance in EM equities.
As I said, it’s been an incredible run performance-wise, and the build-up in EM ETF assets is astounding. It’s about this time that the contrarian in the room stands up and says “it looks so good that it’s bad”. In other words, there can be information in ETF asset flows (too much too quick can be a contrarian sign… remember Buffett’s words on greed vs fear and market timing), the other thing is that valuations will have been pushed up by this blistering pace of gains in price. So it’s worth taking a look at where things stand valuation-wise, and the charts below shed some light on the situation.
The main things to note on EM equity valuations are:
-After very strong performance (85% since 2016 in USD terms) and substantial net inflows EM ETF AUM is at a record high ($180B+).
-Unsurprisingly then, absolute valuations have been significantly re-rated (on a couple of measures), and EM equities are not cheap anymore.
-Yet absolute valuations can’t really be called expensive at this point either.
-Furthermore, compelling relative value remains evidence vs developed market equities.
1. EM ETF AUM: As mentioned, Emerging Markets ETF Assets Under Management have seen an incredible move. After rising 204% or US$121 billion, they now total over $180 billion. Price has done some of the work (EM equities are up 85% in USD terms), but whatever way you look at it there has been substantial fund flows into emerging market equities, and this is something to note from a contrarian standpoint.

2. Valuations – Forward PE: Looking at forward PE ratios, in absolute terms they are at the upper end of the historical range… at least the post-2001 period. They look less expensive vs the 80’s and 90’s but that was quite a different environment. On relative valuations (EM vs DM) they’re still trading at about a 25% discount, which by itself is interesting and is also reasonable given the historical range of the relative valuation discount/premium. So in absolute terms they are NOT cheap, yet relative value remains.

3. Valuations – PE10: Taking another angle on valuations – the PE10 (which we have talked about a lot lately) – the conclusion is somewhat similar. While the EM PE10 has risen back to about average levels (again not cheap any more), it’s still comfortably below the 2006-2011 period, and likewise still trading below their developed market counterparts. So the luxury of cheap absolute valuations as a reason to be long has come and gone, but the relative valuation argument remains compelling, for now.