Stop worrying, emerging markets still have the fire power

Stop worrying, emerging markets still have the fire power
1 May, 2008, 0828 hrs IST,

LONDON: Emerging markets are very likely the next bubble, but don't
let that stop you.

Emerging market shares are already expensive relative to developed
market ones, but economic growth in places like China and India will
continue to pull away, and investors will pay an increasing premium
for that, especially if the ageing economic giants of the 20th century
slip from their long term growth paths.

And in a process we've seen before with internet stocks and houses,
big returns will attract big money, driving further rises and making
it all seem very sensible, at least for a while.

The definition of "a while" is of course, as with all bubbles, the key
question.

Amazingly, the case for emerging markets being both a bubble and a
good investment is being made by legendary value investor Jeremy
Grantham.

"This bubble, like all bubbles, will not be justified by long-term
value but at least will be one of the least flaky bubble cases ever,"
Grantham, chairman of fund manager GMO, wrote in a note to clients.
"Perhaps once in a career any self respecting strategist, even a one
trick 'mean reversion' one like GMO, should have a go at predicting a
major divergence, a true bubble. And this is ours." He points out that
US gross domestic product has in recent years been growing at below
its long term 3.5% rate in real terms, despite a very supportive
global environment and huge amounts of cheap financing.

At the same time, growth in emerging markets is higher, and is
supported by boom prices for commodities and by a seemingly
unstoppable movement of people into cities, driving both consumption
and higher productivity.
Grantham's thesis, essentially, is that these diverging trends will
continue, that everyone will realiae it and that they will pile into
emerging markets, thus inflating the bubble. How big a bubble?

The Japanese bubble peaked at a price to earnings ratios two to three
times that of the rest of the world's stocks, while the Nasdaq one
reached similar figures, according to GMO. Grantham argues that
emerging markets could achieve a premium of 50 percent, which would be
"far less than normal," but still a heck of a lot higher than current
levels. Emerging market shares are now more expensive on a reported
earnings basis than developed market stocks, a historically unusual
situation.

Emerging shares are now selling at 15.9 times their reported earnings,
as against just 14 times for developed markets. The median over the
past 13 years is 15.6 for emerging and 22 times for developed,
according to data from Societe Generale. So, investors are paying more
for a dollar in emerging markets earnings than they will for a
developed earnings dollar, and a major relative change in valuation
has already happened.

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