Paris/London: The last time stocks in developing countries got this expensive was in October 2007, just before the MSCI Emerging Markets Index began a 12-month tumble that erased half its value.
The MSCI gauge trades at 15.4 times reported earnings, compared with 14 for the Standard and Poor’s 500 Index, according to weekly data compiled by Bloomberg. When developing nations last commanded a premium, the 22-country benchmark sank 54% in the next year.
Groupama Asset Management, Palatine Asset Management and Standard Life Investments say the disparity means investors are paying too much for shares from China to India to Brazil at a time when the global economy is contracting. MSCI’s emerging-market gauge is valued at 1.7 times its companies’ net assets after a 34 percent surge last quarter, the highest on record compared with the MSCI World Index of 23 advanced economies, which trades for 1.5 times, data compiled by Bloomberg show.
Worth the risk? A trader works at the Bovespa exchange in Sao Paulo, Brazil. Analysts say investors are paying too much for shares from China to India to Brazil at a time when the global economy is contracting. Paulo Fridman / Bloomberg
Emerging-market stocks are at risk, said Matthieu Giuliani, a Paris-based fund manager at Palatine, which oversees $5.56 billion. “You should only pay so much for growth.”
Investors are already starting to show a lack of confidence in a continued rally. MSCI’s developing nation index has dropped 9.7% from its 2009 high on June 1, while the MSCI World fell 7.7% and the S&P 500 retreated 6.8%.
Emerging market funds had $540 million of net outflows in the week ended July 8, the second time in three weeks investors withdrew money, according to Cambridge, Massachusetts-based EPFR Global, which tracks funds with $10 trillion worldwide.
All 22 emerging-market currencies tracked by Bloomberg depreciated against the yen in the past month, and 16 weakened against the dollar. The yen attracts investors during economic turmoil because Japan’s trade surplus makes the nation less reliant on overseas lenders, while the dollar benefits from its status as the world’s reserve currency.
While developing nations’ economies grew an average 1.7 times faster than developed countries in the past 20 years, their stocks traded at a discount because their economies and returns were more volatile.
The MSCI emerging market index had 13 bull market rallies of at least 20% and 12 bear-market declines of the same magnitude since its inception in December 1987, according to data compiled by Birinyi Associates Inc., the Westport, Connecticut-based research and money management firm founded by Laszlo Birinyi. That compares with five bull markets and four bear markets for the S&P 500 during the same period.
Developing nations led the rally in equities last quarter, with China’s Shanghai Composite Index adding 25% and India’s Bombay Stock Exchange Sensitive Index jumping 49%. The gains outpaced a 20% rise in the MSCI World and a 15% advance in the S&P 500.
The increase cut the dividend yield of the emerging market gauge to 3%, compared with 3.5% for developed countries.
MSCI’s emerging market index fetches one times sales and 6.6 times cash flow, compared with 0.8 and 4.3 in the advanced gauge, data compiled by Bloomberg show.
Gains came too quickly in the context of a slow economic rebound, said Romain Boscher, who helps oversee $119 billion as a director at Groupama in Paris. “Valuations are now high, and that leaves the door open for a drop.”
Alexis Xydias in London and Lynn Thomasson in New York contributed to this story.