Exploring Emerging Markets

WITHIN two years of the dotcom bubble bursting in 2000, the tech-heavy Nasdaq index lost three-fourths of its value. This isn't 25 years ago, but if you think the U.S. stock market is getting too expensive for its own good, you have a reasonable case.

- STREET SMART BY JAMES K. GLASSMAN

The benchmark S&P 500 index now carries a price-earnings ratio of just under 23 for the year ahead. That is disturbingly close to its high before the 2000 crash. All but one of the index's top 10 components is a high-flying technology stock; together, those giants account for more than one-third of the value of the index.

I am not saying you should sell shares in the hope of buying them back cheaper. Market timing is a fool's errand. But this is the right time to look for some inexpensive stocks to balance your portfolio. A good place to hunt: emerging markets.

So far this year, iShares MSCI Emerging Markets (symbol EEM, $50), a popular exchange-traded fund based on an eponymous index, has returned 20.4% through the end of August (the date for prices and returns in this column; recommendations are in bold). That's nearly twice the gain of the S&P 500. Despite the rise, the average P/E of the stocks in the ETF's portfolio is just 14. There is no generally accepted definition of the term, but an emerging market is one that's developing into an advanced industrial economy but isn't there yet. Emerging markets cover a lot of ground—from Pakistan, with a gross domestic product per capita of about $1,500, to South Korea, at $36,000.

The MSCI Emerging Markets index includes 1,189 separate stock issues, weighted by their market value. The index captures 85% of the value of all large- and midsize-company stocks from 24 countries, but those of just a handful predominate. China's shares account for 30% of the index; Taiwan, 19%; India, 16%; and South Korea, 11%. In other words, when you buy an emerging-markets index fund, you are mainly buying Asia (which, after all, has three-fifths of the world's population).