(James Saft is a Reuters columnist. The opinions expressed
are his own)
By James Saft
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
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
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
He points out that U.S. gross domestic product has in
recent years been growing at below its long term 3.5 percent
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 realize it and that
they will pile into emerging markets, thus inflating the
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.
DECOUPLED, WEAKLY COUPLED OR TIED AT THE NECK?
Emerging market shares are now more expensive on a reported
earnings basis than developed market stocks, a historically
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
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. Can this continue, even if growth in the United
States and Europe is weak?
Andrew Lapthorne, global quantitative strategist at Societe
Generale Corporate & Investment Banking in London, is not so
"Are emerging markets a commodity play? Yes. Do they have
better growth prospects? Yes. Can they withstand a slowdown in
the United States and Europe? Probably not," he said.
Grantham, for his part, believes that the bubble will be
influenced, and perhaps delayed, by problems elsewhere.
"Such interruptions may be quite violent but, despite them,
at the next low point for the U.S. market the emerging markets
are quite likely to do no worse and in the recovery they will
go to a very large premium," he writes, adding that in the
slower case the 50 percent premium would be reached within five
years. If the United States somehow skates through, then it
would be all the faster.
There are other arguments in support of emerging markets
that are actually strengthened by the woes elsewhere. Leverage
is lower in emerging markets than developed, both at the
corporate and household level. If we are going through a
sustained period of lowering the amount of borrowing that is
acceptable, Asia's banks and consumers are less exposed.
And the increasingly affluence of consumers in emerging
markets offers another potential stabilizer. Credit Suisse
points out that about half of global emerging market exports
are to other emerging markets, as against 18 percent to the
There is also a school of thought that says, like it or
not, global financial capitalism is inherently prone to
bubbles, so we should all just relax and enjoy it.
Indeed, since the Federal Reserve and other authorities
have demonstrated that they will step in to cushion the effects
of a popping bubble but not act to stop one inflating, you can
be forgiven if you think it might be fun to hitch a ride.
It may be moral hazard, but what, after all, is a
speculator to do?
Just make sure you get out good and early.
-- At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. email:
(Editing by Ruth Pitchford)