Emerging Markets Are Attractive

Chart 1: Fund managers are extremely underweight Emerging Markets

 Source: Short Side of Long

In the recent Merrill Lynch Survey for the month of March, fund managers reported largest underweight position on Emerging Market equities since inception. Managers are currently underweight this equity region by -31%, which is almost 3 standard deviations away from a decade long average. That is quite a bearish sentiment reading right there! As readers can see from the chart above, fund managers were overweight GEM equities by +43% in February 2013 but nervously switched this position quite rapidly over the last year.

Chart 2: Cash balance levels have increased due to GEM equity sell off

 Source: Short Side of Long

Not only are fund managers currently extremely underweight this region, after being highly exposed to it only a year ago, but they are also rising their cash levels as Global Emerging Markets (GEMs) equities disappoint. The fact that cash balance levels highly correlate with GEM Equity lets us know that majority of the managers had high exposure to regions outside of US and EU just until recently.

In the chart above, there is a possibility in coming months that GEM Equities might technically break down from the current consolidation zone, at which point cash balances would rise towards 1.5 standard deviations away from mean and indicate a contrarian buy signal. Similar setup was seen during the 2008 and 2011 crashes, were cash levels spiked pretty quickly.

Chart 3: Emerging Market stocks are cheap & ripe for buying pretty soon

 Source: Barclays Research

Some of you are wondering, with all of the negative media coverage, why in the world should one buy Emerging Market equities?

Well, the answer is precisely because everyone dislikes them so much. Even more importantly, GEM Equities are starting to look extremely attractive from long term valuation standpoint. Last week, the overall MSCI EM Index traded at 1.4 price to book value, cheapest since the depths of the Lehman panic in 2008. As we can see in the chart above, that is usually a buy zone (even though I personally think that P/BV could fall closer towards 1 before the major low is in).

Having said that, plenty of Emerging Markets are already trading close to or even below book value including South Korea, Brazil, Russia, Egypt, Czech Republic, Poland and many others. Even China is trading at 1.4 times book value, which is relatively much more attractive then the overvalued and euphoric US market.