It's only natural for bargain-conscious investors to worry about paying premium prices for stocks right now. After all, with the Dow Jones Industrials (DJINDICES:^DJI) having hit an all-time record high yesterday, the U.S. stock market has completed a round trip that went from the Dow's having lost almost 55% of its value from late 2007 to early 2009 to its having jumped nearly 120% -- just to earn back those losses and return to breakeven, excluding dividends.
By contrast, many investors are much more comfortable investing in markets that are trading well below their record highs -- yet which have at least some chance of returning to previous high levels in the future. With that goal in mind, I scoured the world to find three markets that have plenty of room to run and attractive valuations to boot.
If you want rock-bottom earnings multiples, then Russia's the place for you. Trading at a forward P/E ratio of between 5 and 6, Russia's major market benchmark is still well off its all-time high of about 2,500 back in early 2008, now trading below 1,500.
By those measures, Russian stocks seem at first glance to embody the concept of margin of safety. The problem, of course, is that Russia earns its valuation discount for a couple of good reasons. First and foremost, its political system is unreliable, with a history of legal actions against rich capitalists. Given the nation's history, investors automatically incorporate lower valuations to reflect the possibility of capital loss from government nationalization of private assets.
But the other reason for Russia's discount comes from its reliance on natural resources, which are undergoing a cyclical downturn at the moment. In the long run, though, extensive energy and mineral assets should come back into favor. If you're willing to take on the risk of a collapse of capitalism, then Russian valuations compensate you pretty well for that risk. A broad-based investment in ETF Market Vectors Russia (NYSEMKT:RSX) may be your best bet to get Russian exposure.
Chinese valuations aren't nearly as attractive as Russia's, despite their shared communist histories. But with the Shanghai Composite having fallen more than 60% from its high above 6,000 in 2007, long-term China bulls have plenty of value-based arguments to use.
Investing in China has more than its share of political risk as well. But China also has a vested financial interest in giving Western industries a chance to sell their goods to Chinese consumers, given the amount of credit China provides the U.S. Treasury. Despite concerns about a potentially overheating property market, slowing growth rates from the country's hypergrowth period over the past decade, and issues of fraud among certain Chinese companies, some Chinese stocks present good opportunities right now. Avoid all-market investments like iShares FTSE China 25 (NYSEMKT:FXI) in favor of individual companies at compelling valuations like Baidu (NASDAQ:BIDU), which is down 40% from its all-time high on exaggerated concerns about new competition.
3. South Korea
The South Korean market isn't all that far from a record, with the Kospi just 10% or so below its all-time high. But valuations in South Korea are extremely low, as stocks fetch between eight and nine times earnings right now. Although some analysts point to stingy dividend payout rates as a reason for the valuation discount, Korea nevertheless has huge growth potential, especially in light of regional strength from neighboring China.
One interesting trend that has brought Korea into the forefront is an index switch by Vanguard. By shifting its emerging-market benchmark from a MSCI-managed index to one created by FTSE, Vanguard's emerging-market funds will eliminate their South Korean exposure.
But one reason that Korea may have stayed so inexpensive is that few of its stocks trade on major U.S. exchanges, including giant Samsung. Relying on iShares MSCI South Korea (NYSEMKT:EWY) is a reasonable way to get exposure to South Korea while the market is still relatively cheap.
If U.S. stocks seem too expensive, jumping into cheaper foreign markets deserves consideration. The risks can be much greater, but for the right returns, that risk may well be worth taking.