(Bloomberg News) The biggest outflows from emerging-market equity funds since January 2008 may be a signal to buy stocks at the lowest valuations in 2 1/2 years.

Investors pulled $7.7 billion in the week to Aug. 10, the third-largest withdrawal on record and about 1.1 percent of assets under management, according to research firm EPFR Global. The MSCI Emerging Markets Index jumped an average 17 percent in the six months after outflows of this magnitude during the past decade, posting gains on 11 of 12 occasions, data compiled by EPFR Global and Bloomberg show.

The MSCI gauge sank as much as 20 percent from its May 2 high this week on concern the U.S. economy is stalling and Europe's debt crisis is worsening. The slump sent valuations 30 percent below the 20 year average at 8.9 times analysts' 12- month profit estimates, data compiled by Bloomberg and Morgan Stanley show. Fund outflows are a contrarian signal for rallies because they show pessimistic investors have already sold, according to Commerzbank AG's Michael Ganske.

"When things are selling off and investors are very bearish and panicking then it's clearly a good time to add positions," Ganske, head of emerging-markets research at Commerzbank in London, said in a phone interview. "There is clearly a compelling argument to reassess exposure in emerging equities as valuations are very, very cheap."

The strategy of buying emerging-market stocks after weeks when outflows exceeded 1 percent of assets under management produced average gains of 2.2 percent in one month, 8.5 percent in three months and 28 percent in 12 months, according to data compiled by EPFR Global and Bloomberg.
History Shows Gains

Investors have also been rewarded for buying when the MSCI emerging index fell below 9 times earnings. The last dip to those levels in October 2008 was followed by a 60 percent rally during the next 12 months, data compiled by Bloomberg show. The gauge climbed 44 percent in the year after valuations tumbled that low in August 1998, the month Russia defaulted on $40 billion of debt, the data show.

The MSCI index was little changed today after two days of gains. Reports today showed French economic growth stalled last quarter and euro-region industrial production unexpectedly fell in June.

The 21-country gauge has retreated about 5 percent this week after an unprecedented downgrade of America's top credit rating by Standard & Poor's and signs that Italy and Spain may struggle to refinance debt. The MSCI Emerging Markets Energy Index sank 7 percent, the most among 10 industry gauges, as oil prices tumbled.
'Growth Scare'

A further retreat in commodities may spur more outflows from developing-nation equity funds, according to John-Paul Smith, emerging-market strategist at Deutsche Bank AG in London.

"Over the short term it's most likely a by-product of the global turmoil rather than a change of view on the relative attractions of emerging-market equities," Smith said. "The real damage is likely to happen further out if, as we expect, investors become more negative about the fundamental prospects of both emerging markets and commodities."

The MSCI index fell more than 15 percent in a month after fund outflows reached more than one percent of assets in August 2001, while the gauge retreated 6.5 percent when withdrawals exceeded that level in May 2006, data compiled by EPFR and Bloomberg show.

This week's retreat in emerging-market share prices has produced buying opportunities and slowing growth in the developed world may ease inflation pressures in developing nations, said Ivo Kovachev, an emerging-markets money manager at London-based JO Hambro Capital Management Ltd.

The People's Bank of China will leave borrowing costs unchanged for the rest of this year, according to eight of 10 analysts surveyed by Bloomberg this week. The Bank of Korea kept interest rates unchanged for a second month on Aug. 11, while Indonesia stayed on hold Aug. 9.

"There has been a growth scare in the world," said Kovachev. "But perhaps a bit perversely, it may help emerging markets because this year they were suffering from overheating and inflation risk."