Emerging markets: Not yet the flavour

Having clocked an annualised returns of 33 per cent in the last five years, emerging markets are down more than 20 per cent this year. According to a Merrill Lynch report, in the past ten weeks or so, there have been $20 billion dollar worth of redemptions from long-only funds.

Understandably investors are anxious about their money.That will make life difficult for fund managers, compelling them to to pare their positions. It’s not that the markets are very expensive : The MSCI EM Index currently trades at a price-earnings (P/E) multiple of around 12.1 times trailing earnings and 9 .3 times forwards.

Moreover, most emerging markets should maintain their growth advantage in the coming years. However, for the time being, with the credit crisis in the US not quite over and signs of a slowdown beginning to happen in Europe and Japan, even fund managers who have money to invest, are likely to stay away from these markets.

The drop in oil prices may have sparked a rally in some markets including India, leading to a temporary outperformance. However, the Indian market is down nearly 29 per cent from its January 17, 2008 peak and stays one of the biggest underperformers in the region. Again, it’s not that valuations are at stratospheric levels.

In fact, a market that was being pursued at a price earnings multiple (P/E) of 22 times is now being shunned at 14.5 times. But these multiples are still among the highest in the region. Which is why brokerages such as Goldman Sachs still prefer China now that India trades at a hefty premium of about 30 per cent to HK-listed China stocks for a comparable consensus earnings growth.

Also, while oil prices may have come off, there is a chance that they could rebound. India tends to be the worst hit when oil prices rise because retail prices of petrol and diesel are subsidised by the government, which hurts the fiscal deficit. Moreover, the continuing high inflation—nearly at 13 per cent levels—and high interest rates threaten to hurt purchasing power and slow down the economy .That will surely mean lower earnings growth, keeping the market expensive.