Don't Lose Your Shirt in Emerging Markets

Another sign that the emerging markets may be overheating comes from recent data from the Financial Research Corp., which tracks U.S. mutual fund sales. FRC's latest data show U.S. investors were jumping on the Asia-Pacific bandwagon in increasing numbers last year -- even after the funds already had posted several years of 20%-plus gains.

Net sales of Asia-Pacific funds more than doubled in 2006 to $7.3 billion, including nearly $1.3 billion in December alone. Investors also pumped $12 billion in other emerging-markets funds during the year. Retail investors, as usual, tend to be late to get in on the action. People weren't pouring money into these funds back in 2001 and 2002, before the big gains.

The strongest arguments for investing in Asia in recent years have been that the economies there are booming and the shares were relatively cheap. But Bijal Shah, chief market strategist at SG Securities in London, points out that Indian stocks are no longer inexpensive.

In fact, "India's valuations are in stratospheric territory," he says. "A bubble is forming." Even though company earnings have soared over the past four years, Shah says, investors today are willing to pay much more for each dollar of earnings in the hope that this growth will keep going. "This same logic applied in the U.S. in the 1999 and 1987 bubble years."