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March 14, 2006
Are emerging markets facing bubble trouble?
Heady returns in emerging market assets in the past three years have caught the attention of even the most risk averse investors such as pension funds.
But investors are now closely examining what is being served up in front of them as the rich valuations of emerging market currencies, stocks and bonds wobble in the face of global central banks raising interest rates.
Some analysts go as far as saying that investors may have underpriced or mispriced country risks and are highly vulnerable to a sell off in global financial markets.
Emerging markets have indeed been booming.
Russia's benchmark RTS index <.IRTS> soared 130 percent between early May 2005 and the middle of last month.
On average markets in the six Gulf countries were up 92 percent last year. The Saudi Index <.SASI> ended 2005 up 104 percent and more than 600 percent up from 2002. The Dubai index <.DSI> rose 130 percent last year.
In contrast, the FTSEurofirst 300 Index <.FTEU3> gained about 22 percent in 2005, while the S&P 500 <.SPX> rose just five percent.
Armed with ample cash and low interest rates, investors turned more risk-loving and chased returns in high-yielding emerging markets.
For example, Ashmore Investment Management, which manages $18 billion (10 billion pounds) in emerging debt and equity, said on Thursday it has been selected by San Francisco Employees' Retirement System to run a $120 million emerging market equities mandate.
But as appetite for risk decreases and central banks in major industrialised economies such as the United States and euro zone raise borrowing costs, investors are turning cautious.
The Bank of Japan scrapped its ultra-easy monetary policy on Thursday, worrying investors about the withdrawal of global liquidity from financial markets and the beginning of the end of the carry trade in which investors borrow in a low yield currency to invest in higher yielding assets.
BUBBLE TROUBLE
The slide in many emerging equity markets and currencies in the past few trading sessions has sparked concern as to whether a bubble is about to burst.
"From what I am reading and seeing I think country risks have been sacrificed in the search for yields," said Simon Derrick, head of currency research at Bank of New York.
Derrick said the current situation bears an uncanny resemblance to the internet bubble in 1999 and subsequent collapse of global stock markets.
Similarly, emerging market investors remember the meltdown of 1997-98 -- the Asian and Russian financial crises -- after hot money flowed into riskier assets.
The Bank of International Settlement in its latest quarterly report raised concerns about whether investors were discriminating sufficiently among borrowers.
It said credit ratings suggested that investors' appetite for risk had helped to drive emerging market sovereign bond spreads to record lows.
"Nevertheless, to the extent that investors may have underpriced country risk, emerging markets could be vulnerable to a repricing," the report said.
Credit Suisse in a client note said structural changes in the pattern of fund inflows show retail investors are focusing on broad-brush macroeconomic themes rather than valuations.
It said tracker funds accounted for 40 percent of inflows into the asset class in January, while actively managed funds saw an outflow during that period.
"This leaves fund inflows, to our mind, potentially vulnerable to business cycle risk, particularly in one of the 'BRICs' (Brazil, India, Russia and China) countries," it said.
DISCERNING INVESTORS?
Investors may already be distinguishing between good and bad sovereign credits and currencies and not relying on high yields to generate returns for portfolios. Take central Europe.
The Hungarian forint has lost about 2 percent so far this year dipping to a two-year low amid the emerging markets sell off on Wednesday despite domestic interest rates at 6 percent.
On the other hand, the Czech crown has firmed 1.25 percent in 2006 despite a negative yield differential to the euro zone.
Economies with macroeconomic imbalances are likely to suffer more if global risk appetite plunges.
But some fund managers say while the recent bout of market indigestion has drawn concern, appetites remain healthy.
A rise in emerging market assets comes against the backdrop of vastly improved fundamentals, chief of which are current account surpluses, built on in some cases by a rise in crude oil and other commodity prices.
"From the broad scheme of things there is some worry about the liquidity overhanging various financial assets, but the fact of the matter is the Fed and others now have a more limited impact on the global liquidity situation," said Rob Drijkoningen, head of emerging market debt and high yield at ING Investment management in The Hague.
-Reuters-
Posted by su at March 14, 2006 9:43 AM