One of my favorite things about my role at Vanguard is that I get to spend a lot of time listening and hearing from investors of all levels of sophistication and from all over the globe. This role affords me the privilege of hearing and seeing what actual investors are thinking about the markets and what they are doing with their investment portfolios. One of the things that I have heard coming up more and more frequently is the idea that emerging markets equities are “cheap.” As such, I thought this topic deserved a closer look.

Indeed, emerging markets equities are currently valued below their historical average.


The good news, as you can see in the chart above showing the price/earnings ratio (P/E) of the MSCI Emerging Markets Index, is that today’s level of around 12 is well below its historical average of 15.5. This is what people mean when they say a market is “cheap”; emerging markets equities are trading at a 23% discount to their historical average.

Now, I think we need to be clear up front that a P/E that’s “lower than average” is not necessarily the same thing as “cheap,” regardless of the time series. It simply means just that; it’s lower than average. Even then, if we dig a little deeper, we’ll see that there is more to the story than initially meets the eye. Yes, emerging markets are currently valued below their historical average, but this is also a relatively very short time series. Not only is the time series short, the period from 1995 through current has been one of elevated P/E ratios globally, which distorts the statistics when comparing current valuations to such a historical average. So drawing any conclusions or strong opinions on such a short horizon, where the averages do not reflect longer histories across other valuations, is problematic.

So where does this leave us? As a reality check, what if we use this same common time series to analyze how other equity market valuations currently stand relative to their historical average? Well, as we can see below, using this common time series, all equity markets are well below their own averages. So is the conclusion that emerging markets equities look “relatively cheap,” or that all asset classes are “relatively cheap” OR is the proper conclusion that the time series is too short, with elevated averages, so making any such statements is highly problematic?

Using equity markets inception time series for other markets, everything is cheap!


Well, obviously, I think you all know my answer here, but to double-check, let’s analyze if the U.S. equity market is “relatively cheap” using its full time series.

The chart below shows that, at least according to two of the most popular P/E measures, U.S. stocks are either slightly overvalued or significantly overvalued. According to the P/E 1 measure, which is the ratio of price to the last 12 months’ earnings, stocks are valued about 5% higher than their historical average and have been more expensive only about 35% of the time. As for the Shiller Cyclically Adjusted Price Earnings ratio (CAPE), which is the ratio of price to the last ten years’ average earnings, stocks are valued 33% higher than their historical average and have been more expensive only about 10% of the time.

U.S. stocks are overvalued relative to their historical average.


So when someone asks, “But, Fran, aren’t emerging markets cheap right now?”, or when I hear that one asset class is overvalued relative to another, my first instinct is to caution that, like always, there is probably more to the story. Several of my Vanguard colleagues took a stab at some of these issues in the paper Forecasting stock returns. What signals matter, and what do they say now? and found that while P/E ratios are the “best” predictor of future stock returns, they are still not very good at it, explaining only about 40% of the variation in real returns over time. Furthermore, their research found that the vast majority of this explanatory power was realized when P/E ratios were at their most extreme high or low values, and even then, only over long time horizons.

My concluding thoughts are that investors would be best served not by investing their portfolio based upon whether a market segment is currently above or below a historical average, but by saving as early and as much as they can while implementing these savings in a coherent investment plan that includes an appropriate asset allocation based upon unique goals, time horizons, and risk tolerance, then rebalancing to this policy.

I’d like to thank Michael DiJoseph for his contribution to this blog.


All investing is subject to risk, including possible loss of principal.

Investments in stocks issued by non-U.S. companies are subject to risks including country/regional risk and currency risk. These risks are especially high in emerging markets.