In aggregate, emerging market stocks trade at a 40% price-to-earnings (P/E) discount to developed U.S. stocks. Does that make emergers cheap? Not necessarily. A number of analysts have pointed out that the 10-year P/E of 25 on U.S. equities has only been surpassed at three other moments in history (i.e., 1929, 2000, 2007). It follows that discounts to overvalued U.S. stocks may mean that emerging markets can be described as undervalued or under-appreciated, rather than unbelievable bargains.
By the same token, calling a bottom in the securities of developing countries is an exercise in futility. Consider the reality that emerging market ETF outflows typically occur when prices are falling. ETF inflows tend to be highest when prices have already skyrocketed. In other words, many investors in developing areas are not particularly successful at capturing price appreciation; they’re selling lower as opposed to buying lower.
Buying low and selling high may be the “phrase du jour” from a value investing playbook. And yet, anyone who watched one-time superstar Bill Miller purchase banks and insurers at supposed deep discounts in 2007 and 2008 recalls the utter decimation of Legg Mason Value (LMVTX). You can think you’re buying low, only to discover that there’s no guarantee that your doing so.
How can you improve your odds of picking up “inexpensive” emerging market stock ETFs at decent price points? Combine the value proposition with confirmation from technical indicators. For example, when panicky investors exit a potentially viable asset, its Relative Prince Index (RSI) reading may fall below 30. This represents an oversold condition. The iShares MSCI Emerging Market Minimum Volatility Fund (EEMV) experienced two significant “sub-30″ periods in the last year– June 2013 and February 2014. In both instances, buying EEMV at the period in question occurred near low points.
Granted, the approach has its flaws. I had been interested in acquiring shares of iShares MSCI Philippines (EPHE) for more aggressive clients since last November. Having lived and worked in Hong Kong, I witnessed the remarkable amounts of cash that oversees workers from the Philippines sent back to their families in Manila. Today, the domestic economy is benefiting from an appetite for consumption as well as new infrastructure spending. Using the above-mentioned approach, I patiently waited for the RSI reading on EPHE to dip below 30 like it had in June and August. However, the event never came to pass.
Patience is an exceptionally important trait that a disciplined investor needs to nurture. I could purchase EPHE right now. The vehicle is well-off the highs it reached one year earlier. The price rose above and may stay above a critical intermediate trendline (i.e., 100-day MA). On the other hand, without the RSI confirmation, I could just as easily run into the trap that mid-October investors are still trying to recover from. Whatever one’s discipline, it is better to stick with your approach than to change it haphazardly.