Overeating at Emerging-Markets Trough

I've written a lot about emerging markets for RealMoney, and in response I've gotten some interesting email from readers. One thing has alarmed me, though: A number of readers have 25% or more of their money in emerging markets. That's way too much.

Finding an equal weight allocation for emerging markets isn't easy, because a lot of the MSCI broad indices exclude emerging markets. There's one that doesn't: The MSCI Global Capital Markets Index allocates 5.5% of its equity weight to emerging markets. Let that sink in.

Emerging markets are very compelling because of the strong global demand for resources and the modernization of infrastructure in places such as China and India. I buy into this in a big way, so I maintain an overweight position for clients at around 7% of equity portfolios. To me, jump-up-and-down bullish corresponds to 7%.

I'm afraid that too many people have way too much riding on emerging markets continuing to do well. There will be other crises similar to the Asian currency panic of 1997. Perhaps they can be timed, but probably not.

In the last three years, the iShares Emerging Market Fund (EEM - commentary - Cramer's Take) is up 200%, compared with 100% for iShares EAFE (EFA - commentary - Cramer's Take) and 50% for the S&P 500. The returns are great, but embedded in those numbers are some astronomical fund flows.

According to AMG Data, in 2005, $13.7 billion went into emerging-market mutual funds, compared with only $200 million in 2004. Factoring in price appreciation, assets in emerging-market mutual funds grew from $59 billion in 2004 to $103 billion in 2005. A lot of investor money is flowing in to chase performance.

Being bullish doesn't correlate to being right. In the 1997 panic, Brazil and Taiwan both fell 25% in four months. It could happen again. Just last week the iShares Emerging Market Fund fell 3% amid a minor panic after the ratings agency Fitch downgraded Iceland's debt.

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Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, Ariz., and the author of Random Roger's Big Picture Blog. At the time of publication, Nusbaum had no positions in any of the securities mentioned in this column, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.