Is now the right time to jump into emerging markets?

After a tremendous five-year run in international markets -- especially emerging markets -- many investors have sought to capitalize on foreign growth by moving assets to other countries. According to a July article in SmartMoney magazine, inflows into international mutual funds topped $117 billion over the previous two years, versus just $18 billion for domestic funds.

Once bitten, twice shy
What's interesting -- and perhaps a bit troubling -- about this figure is that for 1998 and 1999, the fund inflows were outsized in the opposite direction: $327 billion went into domestic funds and only $19 billion found its way to other countries.

Let's recall what's happened since then:

Index-Tracking Investment

Index

Return Since Dec. 31, 1999

SPDRs (SPY)

S&P 500

11%

PowerShares QQQ (NASDAQ:QQQQ)*

Nasdaq 100

(44%)

Vanguard Total International Stock Index (VGTSX)

MSCI EAFE

63%

Vanguard Emerging Markets Index (VEIEX)

MSCI Emerging Markets

196%

*Formerly known as Nasdaq 100 Trust.

So ... buy American?
With capital flooding the foreign markets today, and knowing what happened seven years ago, should you play the contrarian and bet against international stocks?

Now, certainly some of the increased international inflows are from investors blindly and unwisely chasing past performance, but the state of today's foreign markets is a bit different than the Nasdaq circa 1999.

For one, at the end of 1999, the Nasdaq P/E ratio stood at 200 as investors poured their milk money into tech stocks. Included in this lofty tech group were Harmonic (NASDAQ:HLIT), Network Appliance (NASDAQ:NTAP), and Powerwave Technologies (NASDAQ:PWAV), whose P/E ratios were all higher than 200 in December 1999. Unfortunately, none of these companies were able to keep up earnings growth with the market's lofty expectations -- and their stock prices have yet to completely recover.

Many emerging-market stocks, on the other hand, have outpaced earnings growth in the United States. Case in point: The S&P 40 BRIC Index, which tracks large companies in the emerging markets of Brazil, Russia, India, and China, has generated earnings growth of 15% on average since 2002. (The S&P posted a still-impressive 12% in that time.) BRIC component Companhia Vale do Rio Doce (NYSE:RIO), a Brazilian metals business, has grown its earnings at a 60% clip over this period.

Just another BRIC in the wall
If you're either already invested in Chinese or Indian stocks (you're not alone) or simply want to diversify your emerging market holdings, here are three overlooked markets to consider for new money.

Chile: This material- and metal-rich country is often overshadowed by hot-growth Brazil, but it offers a market-oriented economy, a high level of foreign trade, and real GDP growth of more than 4%. Inflation has remained in check since 2000 thanks to high copper prices and increased exports, and unemployment hovers around 7%. There are currently 15 Chilean ADRs, ranging from financials like Banco de Chile to the expected mining companies like Chemical & Mining Company of Chile.  

Taiwan: It's the consummate "high political risk" market thanks to its 60-year-old tiff with China, and Taiwan's stocks generally sport below-market valuations with strong earnings growth. Taiwan Semiconductor (NYSE:TSM), for instance, trades at 16 times last year's earnings and pays out a healthy 4.7% dividend.

Mexico: With more than 80% of its exports and 50% of imports tied to the U.S., Mexico's economic path is linked to its northern neighbor's. And even though it is the 15th-largest economy in the world, Mexico still has plenty of room to grow -- the International Monetary Fund and Goldman Sachs expect Mexico to be the fifth-largest economy in the world by 2040. Mexican stocks were jolted a bit in late 2006 during the contested presidential election, but have rebounded nicely. The country's largest company, wireless communications firm America Movil (NYSE:AMX), has more than doubled in value over the past two years.

Look before you leap
There are always added risks when you invest abroad -- particularly in emerging markets such as the three discussed above. So before investing, be sure to understand the country's political climate, economic philosophy, and level of corruption. These simple factors can either foster the growth of tremendous companies or squash their potential. Could Microsoft have emerged from a country that wasn't friendly to corporate growth?

International investor and Motley Fool Global Gains advisor Bill Mann looks for promising stocks based in countries that support free markets and encourage foreign investment. Just seven months into the service, the Global Gains portfolio is beating both the S&P 500 and the MSCI EAFE indexes. In fact, five of the team's picks hail from the overlooked markets discussed above.

If you'd like to learn more about the Global Gains service, a free 30-day trial is yours. Simply click here to get started. 

This article was originally published on July 9, 2007. It has been updated.

Fool contributor Todd Wenning believes that if you don't eat yer meat, you can't have any pudding. He does not own shares of any company mentioned. The Motley Fool owns shares of SPDRs. Microsoft is a Motley Fool Inside Value pick. The Fool's disclosure policy is like Scotch tape -- it's so transparent.