Emerging-Market Fund Flows Signal Drop to Bank of America

Emerging-market stocks are poised to fall after developing-nation equity funds had the biggest weekly inflows in 10 months, exceeding a level that preceded previous selloffs, according to Bank of America Merrill Lynch.

Investors poured $5.3 billion into the funds in the past week, bringing four-week inflows to 1.7 percent of their assets under management, according to a report dated yesterday from Michael Hartnett, Merrill’s chief investment strategist. That triggers a sell signal from Hartnett’s fund flows “trading rule,” which says four-week inflows totaling at least 1.5 percent of assets under management precede market declines.

Markets most vulnerable to potential sell-offs will be those currently most overbought, such as Turkey, Mexico, China and India, the strategist said. When the last sell signal occurred in February, developing-nation equities peaked in absolute terms a month later, Hartnett said. The average drop after previous sell signals was 4 percent in the following four to five weeks, according to the report.

“Trading Rule thus flashes ‘sell,’ warning emerging markets too crowded and likely to underperform developed markets over the next four to five weeks,” Hartnett wrote.

The MSCI Emerging Markets Index (MXEF) yesterday climbed to the highest level since April 3. The developing-nations measure trades at 12 times estimated earnings after rising 14 percent this year, compared with the MSCI World’s multiple of 13.7, data compiled by Bloomberg show. The developed countries’ gauge has advanced 12 percent this year.

Emerging markets will lag behind developed nations in 2013, John-Paul Smith, a strategist at Deutsche Bank AG in London, wrote in an e-mailed report dated Dec. 10. The view contrasts with Templeton Emerging Markets Group’s Mark Mobius, who said on Dec. 12 developing-nation stocks will climb in 2013, extending this year’s rally, as central banks worldwide add money to the financial system and spur investors to seek higher returns.

Some strategists use fund inflows as a contrary indicator because they may signal investors with a positive view of the market have already purchased shares.

To contact the reporter on this story: Saeromi Shin in Seoul at sshin15@bloomberg.net

To contact the editor responsible for this story: Darren Boey at dboey@bloomberg.net