Have emerging markets moved too far too fast?

What was behind the huge runup in emerging markets in 2009?

With the subprime shock, everybody was looking for safety. And for some strange reason, they thought the U.S. dollar was safe and went into money market funds until January or February of 2009. Then people began to wake up to a few things. One was that the supply of currency would at some time outpace demand, so value would decrease .. that created this incredible liquidity looking for a home as people woke up that they should think about inflation coming down the pike. They weren't getting any yield on dollar deposits, so equities were the obvious answer.

Have emerging markets moved too far too fast?

The percentage increases are a bit misleading because you are coming from a low base. We are only halfway toward the previous high of 1997.

Have we gone too far?

The only measure we have is valuations, and probably the best single measure is price-to-book value ratio. If you look at the average price-to-book ratio based on the stocks in the MSCI Emerging Markets Index, we are only halfway to the 1997 high. The absolute high was three times book, the low was one times book, and now we are at two times book, roughly.

Apart from all the money in the system, what is driving the emerging-market rally?

Fundamentals. If you look at any time period—10 years, 3 years, 1 year—emerging markets have outperformed U.S. and global markets. Their economies are growing faster, four times faster. And during the 1997-1998 Asian crisis [policymakers in] emerging markets realized they needed strong balance sheets at the national and company level and had to build up foreign reserves, which they've done. They were building up reserves, keeping their currencies low, and reducing debt. Their debt-to-gross-domestic-product levels are way below developed markets, and when you look at the foreign exchange picture, it's even more impressive. Russia has $400 billion in reserves; China, $2 trillion. So where do you want to put your money? Obviously, emerging markets are the place.

What themes are you investing around?

Commodities are a main theme. We are looking at $70 per barrel in our model. Another theme is consumers, because the per capita income of consumers in emerging markets is going up.

How do you expect emerging markets to perform in 2010?

You cannot expect the same kind of percentage increases, but that doesn't mean you can't have a very good return. We are not in the mode of selling massively or getting into cash, that's for sure. That's probably the consensus opinion, which is usually dangerous. But we are finding companies with good dividend yields, companies that are growing.

Investment Outlook - Global Opportunities