Emerging Issues?

The emerging issue on today's thread is with emerging markets. We have always tracked mutual fund flows as a way to track retail investor sentiment and the potential for overheated or panic market conditions. According to EPFR Global and the Wall Street Journal, investors have been pouring money into emerging market stock funds faster than any comparable time on record.  In the first half of 2009 they plowed a record $35.5 billion into emerging market stock funds versus a withdrawal of $61 billion from developed market stock funds over the same period. Could this be performance chasing? The MSCI Barra Emerging Market index is up 45%, while the S&P 500 is up just over 8%.

Now let me preface this by saying that a long-term strategic allocation to emerging markets absolutely makes sense; however, when dealing with a very volatile asset class do not feel you must rush to gain exposure as you can wait for a pullback. According to proprietary research and valuation analysis by Societe Generale, emerging market stocks look frothy and overbought. In terms of price-to-book value, emerging market stocks now trade higher than developed markets. The last time these two data points reach similar levels we saw a sharp and scary sell-off in emerging markets. If this were to occur again, we would use that weakness as an opportunity to add exposure to this asset class.