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See the Value of Emerging Markets

Don’t let market commentators steer you toward buying the highs


Many landmarks of the financial world have vanished since I bought my first stock 40 years ago this summer. However, one feature has grown stronger than ever — the tendency of investors to herd after the latest big thing, and ignore everything else.

Wall Street is fervently pushing U.S. stocks, after (of course) the headline indices have more than doubled since March 2009. At the same time, the establishment is trash-talking virtually every other asset class. Bonds? “Rotate” out of them. Emerging markets? They’re “submerging.” Precious metals? Fuhgedaboudit. Gold — and here I quote a well-known personality on the video circuit — is “the ultimate greater-fool trade … no longer taken seriously except by yellow-metal jihadists and other assorted suckers.”

Please understand: I’m not pointing out these derelictions because I hold some kind of grudge against domestic equities. Far from it. I’m concerned, though, that the Street’s one-sided trumpeting of U.S. stocks might tempt investors who already possess a well-rounded portfolio plan to abandon it — at exactly the wrong time.

Eventually, Equilibrium Will Return

Right now, investors in U.S. equities are feeling pretty good because our domestic market has trounced the rest of the world, in dollar terms, since November 2007.

It’s worth recalling, however, that the shoe was on the other foot from 2002 to 2007. Back then, the NYSE lagged far behind other global bourses, and investors thronged to international mutual funds.

I can’t tell you the day or the hour when the pendulum will swing the other way again. What I do know is that equity values overseas have substantially improved. Emerging markets in particular are so cheap that it wouldn’t take much of a catalyst to trigger a major bounce.

At last glance, the MSCI Emerging Markets Index was quoted at only 1.5 times book value, a mere 8% above its trough during the financial crisis. Meanwhile, the S&P 500 Index trades at about 2.5X book and the Dow Jones Industrial Average at an even higher 3.4X. Foreign stocks, and especially emerging markets, deserve to be bought these days … not sold.

Globetrotting Stocks on the Back Burner — for Now

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Specifically, some companies that generate a large fraction of their sales overseas appear to be undervalued relative to the major U.S. market indices.

Take a peek at this chart from Merrill Lynch. Using the price-to-sales ratio as a benchmark, the graph plots the relative valuation of two groups of companies in the S&P 500: those with a big percentage of foreign sales vs. purely domestic companies.

As you can see, businesses that draw a large chunk of their sales from overseas — that includes familiar names like Coca-Cola (KO) and Qualcomm (QCOM) — were stock market darlings from 2005 to 2009. Since the end of 2009, however, as the European debt crisis heated up and economic growth faded in several key emerging markets, the crowd has cooled on stocks with hefty foreign exposure. The globetrotters now fetch their smallest premium over the stay-at-homes since the beginning of the new millennium.

Sooner or later, investors’ overwhelming preference for domestic stocks (vs. foreign-based companies) will flip-flop, but you can take advantage of international values in the meantime.

Dip a Toe into International Waters

But I realize that after the recent plunge in the MSCI Emerging Markets Index, you might be skittish about emerging markets. A good place to start is the iShares MSCI Emerging Markets Minimum Volatility Index Fund (EEMV). If you want the growth emerging markets can provide without the heartburn, EEMV focuses on stocks that have registered below-average price swings.

True to form, the fund has held up much better than the broad emerging-markets indices since late May (when the latest tumble began). The underlying low-volatility index represented by EEMV beat the broad MSCI Emerging Markets Index by an average of 350 basis points (3.5%) per year in the decade ended Dec. 31, 2012. You make more, over the long term, by losing less!

EEMV’s current yield is 1.7%, and it charges a low 0.25% of expenses, or $25 for every $10,000 invested.

Richard Band’s Profitable Investing advisory service helps retirement savers outperform the market without losing a minute of sleep along the way. His straightforward style and low-risk value approach has won seven Best Financial Advisory awards from the Newsletter and Electronic Publishers Foundation.

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