No Emerging Emergency; Even at their May high, the picture for emerging markets was different from the technology bubble of 1999, or even Japan in 1989.

Byline: Ruchir Sharma (Sharma is a co-head of global emerging markets at Morgan Stanley Investment Management.)

Emerging markets seem to be following a financial-market pattern charted by legendary investor John Templeton: "Bull markets are born on pessimism, grow on doubt, mature on optimism and die on euphoria."

In the late '90s, the dramatic underperformance of those assets occasioned much despair. As emerging markets started to rally in early 2003, few believed in their staying power. But then, almost inevitably, came a moment of ebullience, when earlier this year big U.S. retail investment funds began moving in. During the eight months ending in April, their investments alone in emerging markets exceeded the cumulative inflows of the entire previous 10 years.

Alas, how brief it was. With the average emerging-market fund losing a fifth of its value over the past three months, some investors now wonder whether we've entered the final, fatal stage of Templeton's classic manic-depressive cycle. Exuberant talk of a potential "new era" for emerging markets has given way to pessimism. Markets are replete with warnings: how overbought emerging markets have become, how prone they are to boom-bust cycles. News headlines suggest a financial crisis might be looming for the developing world, from equities to commodities.

Evidence of any such reversal, however, remains scant. Any major bull market typically ends in excess: extreme valuations, often accompanied by a rapid pickup in inflation. The fact that after a 200 percent gain, it took just a 20 percent decline to rekindle old fears about the vulnerability of emerging-market equities is--in a perverse way--a positive sign. Many investors haven't yet bought in to the theory that developing countries are approaching the end of their boom-bust cycle. To the contrary, violence suggests they are still in the phase of "grow on doubt, mature on optimism."

Even at their May high, the picture for emerging markets was very different from the tech bubble of 1999, or even Japan in 1989. In those bull markets, investors assigned ridiculous multiples to stocks. Contrast that to current emerging-market multiples. It's hard to recall any bull market that peaked at a price-earnings ratio of 12.

To be sure, profit margins in emerging markets are elevated. Earnings growth can't continue at the breakneck pace of the past three years. But cycles don't end just because earnings growth goes off the boil, nor do serious bear markets occur when corporate balance sheets are in such great health. They ...