Bonanza for emerging markets stirs bubble fears essentially 1998 in reverse. surge driven largely by the Brics. Since their lowest point on August 16, the Brics index had risen 29 per cent by Friday, outperforming emerging markets as a whole over the same period. The world was up 9.5 per cent.
Bonanza for emerging markets stirs bubble fears
By Joanna Chung in London
Published: September 24 2007 22:12 | Last updated: September 24 2007 22:12
Emerging market equities are defying the financial turmoil.
Having staged a dramatic recovery in the past month, more than recouping the losses suffered over the summer, emerging market share prices on Monday pushed to an all-time high to stand 28 per cent above the low seen on August 16, as measured by the MSCI emerging markets index.
But this spectacular performance of assets that usually retreat in times of crisis has raised questions about whether a bubble is developing in emerging markets.
Those questions have been fuelled by the US Federal Reserve’s interest rate cut last week, which triggered a strong rally in stock markets globally.
Rate cuts have produced bubbles before.
One of the unintended consequences of monetary easing during the credit market crises of the late 1980s and the late 1990s – following crises in Latin America, Asia and Russia – were bubbles in the Japanese equity market and the technology stocks sector, said Michael Hartnett, emerging market equity strategist at Merrill Lynch.
“It’s essentially 1998 in reverse,” he said.
“The credit problem is now in the US rather than emerging markets. So liquidity to ease the US credit problem will be redirected towards emerging markets just as liquidity to ease the Asian and Russian financial crisis and problems stemming from Long-Term Capital Management was redirected toward technology.”
He added: “If the global economy avoids recession, then we continue to forecast an investment bubble in the fundamentally strong emerging markets.”
Some analysts said some markets, including the Chinese and Hong Kong stock markets, were already exhibiting bubble-like features.
The surge in emerging market share prices has been driven largely by the Bric economies (Brazil, Russia, India and China). Since their lowest point on August 16, the Brics index had risen 29 per cent by Friday, outperforming emerging markets as a whole over the same period. The world was up 9.5 per cent.
Kingsmill Bond, chief strategist at Troika Dialog, a Russian firm, said there was “over-enthusiasm driven by the lure of the carry trade” for some high-yielding currencies such as the Turkish lira and the Brazilian real.
According to EPFR Global, which tracks fund flows, emerging market equity funds saw net inflows of $2.5bn last week, their fourth straight week of inflows. Over the past four weeks these funds have taken in $8.2bn of the $13.2bn they have received this year.
Arnab Das, global head of emerging markets research at Dresdner Kleinwort, said: “In general, emerging market equities and currencies are doing better than credit, which reflects the turmoil in US and global credit markets.”
However, emerging market bonds are also proving remarkably resilient. The risk premium between emerging markets and US Treasuries, as measured by JPMorgan’s EMBI+ index, recently dropped below 200 basis points, and was yesterday trading at 192bp – after rising to just over 250bp in mid-August.
Many analysts said the continuing appetite for emerging market assets was justified, not least because of the strong growth and high foreign exchange reserves of many economies in Asia and Latin America.
The strength of commodity markets was also supporting sentiment.
Mr Das said: “A bubble is possible in emerging markets just as in other markets?.?.?.?but though emerging market risk premia might correct along with many other markets, we think we’ll continue to see what is already unfolding – outperformance of emerging markets relative to other asset classes.
“If a bubble does develop, it will eventually, inevitably, burst.
“But the good news is that emerging economies should be insulated from the worst effects if they maintain prudent policies, including high foreign exchange reserves, low net debt and strong fiscal accounts.”
Jonathan Garner, global emerging markets strategist at Morgan Stanley, said that on a valuation basis the MSCI EM index, a market benchmark for equities, was trading at 18 times the trailing price earnings ratio, the top end of the historical range, though well below previous peak levels.
“I would not describe this situation as a bubble but rather a mature bull market based on strong underlying economic performance and corporate earnings growth.
“Of course, we need to watch closely to see whether at some point these fundamentals become excessively priced in to the market, but I don’t think that has happened yet.”
John Cleary, who runs Focus Capital, an emerging market fund of funds, estimates that the overall market capitalisation of emerging market equities and bonds makes up less than 15 per cent of the world market cap, yet emerging economies account for some 50 per cent of world gross domestic product.
“It is true that there has been an indiscriminate rise in all emerging markets, with everyone buying whatever they can, and some markets will fall more sharply than others,” he said.
“But the potential for growth in emerging economies means that valuations in some emerging markets right now are justified.”
Additional reporting by Stacy-Marie Ishmael in New York
Copyright The Financial Times Limited 2007 |
