Why I'm Getting Bullish on Emerging Markets Right Now

Why I'm Getting Bullish on Emerging Markets Right Now 
By Chris Mayer, editor, Mayer's Special Situations

For most of the past five years, the world's biggest investment story has been the growth of the BRICs.

This is the acronym for the countries of Brazil, Russia, India, and China. All four have huge populations and rapidly growing economies. And all four draw a tremendous amount of attention from investors.

The MSCI Emerging Markets Index (which has a heavy weighting toward the BRICs) rose 40% last year, even while the credit crisis swallowed banking profits and hobbled balance sheets around the globe.

And why not? The emerging market story was powerful and seductive. Large populations building more factories, power plants, and roads; burning more oil, coal, and gas; eating more meat; buying more cell phones; installing more Internet connections; and on and on. It was a huge growth curve jammed in a short amount of time. And it seemed to have a long way to go.

But this story has changed a lot in 2008...

Investors no longer love the emerging markets. With a global slowdown in the offing, investor sentiment has shifted hard and fast. Through August 29, China's Shanghai Composite dropped 52% this year. India is down 37%. Russia is off 27%. Brazil seems to have gotten off easy, down only 5%. The damage looks even worse, though, when you consider how far these markets are off their highs.

Bespoke Investment revealed the claw marks of the bear market at work. China is off by 64%. Russia down 41%. India took a breather at negative 32%. The question now is do we buy, sell, or hold? The short answer: Emerging markets are a buy – with a caveat.

The selloff is making things striking on the valuation front... which makes me bullish here. As you can see from the chart below, emerging markets haven't looked this cheap on a forward earnings basis in 20 years...The fall in emerging markets is not an isolated event. It's happening within the broader bear market hitting world markets. Based on past cycles over the last 38 years, we've still got a little way to go before we hit the average share price damage of past cycles. What's also interesting here is how strong returns are one year after reaching bottom. If we hit bottom this month, we could see strong returns in the next 12 months.

Bear Markets of the Past MSCI  World Peak MSCI  World  Trough Days from  Peak to  Trough Peak-to- Trough  Returns Return One  Year After  Trough 1/29/70 7/30/70 182 -20% 28% 1/30/73 10/30/74 638 -45% 26% 8/13/81 8/12/82 364 -20% 50% 8/25/87 12/04/87 101 -27% 23% 1/03/90 9/28/90 268 -29% 23% 7/20/98 10/08/98 80 -24% 40% 3/24/00 3/12/03 1,083 -52% 40% Average   388 -31% 33% Current Cycle Comparison* 10/12/07 7/15/08 ? -22% ? *Using Total Return Index. Price Index peaked 13 July 2007 at 1,206.3. Source: Fact Set MSCI.

Emerging markets could rebound with even bigger returns because the valuations are lower than in the mature markets and the growth rates are better.

So I think emerging markets are a long-term buy. The caveat is simply that all emerging markets are not the same. Some will perform better than others.

As for which ones specifically, my long-time readers know I favor India. I'm in the same camp as Steve and Tom (read their thoughts here and here) when it comes to that country. Russian stocks are also interesting at these levels. Russia as an investment has some "warts" on it, but it's extremely rich in natural resources. It's also cheap... trading for eight times 2009 earnings.

Which countries you ultimately choose to buy won't be as important as the larger picture here. The BRIC story is a long-term idea. These countries are going to be a lot richer and more powerful in 10 years than they are now. And right now, they're as cheap as they've been in a long time.

Good investing