Are emerging markets still cheap, or is the whole world nuts?

Get ready to read a lot of columns in the next decade or so just like this latest one from the FT, whereby asset managers and analysts argue over whether equity valuations in emerging markets are fair (and/or still understated), or whether the acceleration of capital into them has been a bit too fast and furious.  This of course begs the real conundrum, which I personally subscribe to: yes to both. 

Consider the following: “While emerging economies now account for more than 30 percent of global GDP, U.S., European and Japanese financial institutions have between them only about 2-7 percent of their $50,000bn of assets in the emerging world.”  That said, an International Institute of Finance (IIF)  report from earlier this week “sharply raised its forecast for capital inflow into emerging economies from an April prediction of $709bn to $825bn.  For the IMF, fund managers' habits are the core of the problem: with a powerful herd instinct, they tend to move together and risk swamping markets with their buckets of money. As the Fund's report says: ‘Investor flow data suggests emerging markets tend to suffer from herding behaviour.'”

Meanwhile, even in the doldrums U.S. 3Q earnings should be positive enough to lift equities past election time and into the shopping season (a coincidence?), at least if you buy into the estimates.  Yet one indicator I can't get past in the seemingly endless ‘buy risk' phase we're in is the U.S. 10-year yield, which rose to 2.795% on September 10th, but has since fallen to levels not seen since the beginning of 2009 (2.3353 as I type).  Since 10-year yields historically track nominal GDP growth, yields may be lower than they theoretically should be—the latest and final estimate of 2Q10 annualized GDP growth was revised up to 1.7% from the second estimate of 1.6% (and the advance estimate of 2.4%).  At the moment, therefore, bond yields indicate either growth and/or inflation will fall.  Meanwhile, the continued downtrend of the dollar index indicates that the market is heavily pricing in the probability of further long-term asset purchases by the Fed when it next meets on November 2nd in order to kick-start inflation (core CPI 0.9%, core PCE 1.4% y-o-y).  Against this backdrop of further monetary accommodation in both America and possibly the UK as well, precious metals such as gold and silver continue to trend sharply upwards.  Along with emerging equities and safe haven bonds.