Navigating Emerging Markets Stocks

Valuation metrics should be viewed in context

In William Bernstein’s Deep Risk, the third of his “Four Horsemen of Financial Disaster” is confiscation.

What does this mean? Bernstein describes what happened in Argentina in 2001. Facing economic troubles, the government first froze all bank accounts. Then, it forced everyone to convert their savings into government bonds at a disadvantageous rate.

This doesn’t seem like the sort of thing that could happen in the United States. And I agree it seems unlikely today. But if you have a globally diversified portfolio, this kind of thing is a risk. That’s especially true with emerging markets countries, such as Argentina, along with China, Russia and other countries with authoritarian regimes.

That helps explain, I think, why the valuations of those countries’ stock markets are often cheaper than those of developed countries. Those lower valuations shouldn’t be interpreted as making those markets more attractive. Rather, those lower valuations are indicative of a higher level of risk. This is why I recommend only a small allocation to emerging markets stocks.