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Emerging Stock Rally May Fade as Bulls Increase, Strategists Say

The biggest purchases of emerging-market stocks by global money managers in more than a decade and the largest mutual-fund inflows in 15 months are signs to Bank of America Corp. and Morgan Stanley that the rally in developing-nation shares may pause.

A net 44 percent of investors surveyed by Bank of America this month said they had “overweight” positions in emerging markets, up from 20 percent in January, the biggest monthly increase since 2001, according to a report today. Developing-nation stock funds lured $5.8 billion in the week ended Feb. 8, the most since October 2010, EPFR Global data show.

The MSCI Emerging Markets Index has gained 15 percent in 2012, the best start to a year since 1991. The surge in optimism is a contrarian indicator that may signal the rally has gone too far, too fast, according to Jonathan Garner, the chief Asia and emerging-market strategist at Morgan Stanley. Investor holdings in emerging markets have climbed to a level that historically foreshadowed short-term underperformance, Michael Hartnett, the chief global equity strategist at Bank of America, wrote today.

Bets on emerging markets are “dangerously high,” Hartnett wrote. Developing nations are the most-favored investment destination for equities among global money managers who participated in the survey, he said.

Relative Valuations

The MSCI emerging-market index has outperformed the MSCI World Index by about 6 percentage points this year as better-than-estimated data on global manufacturing and the American job market spurred speculation that the world economy will weather Europe’s debt crisis.

The advance has narrowed the valuation discount on emerging-market stocks versus developed-nation shares to about 15 percent from 20 percent at the end of September, according to data compiled by Bloomberg. The MSCI emerging-market gauge trades for 12 times reported profits, compared with 14 times for the MSCI World, the data show.

The emerging-market index slipped 0.3 percent to 1,050.38 at 1:27 p.m. in London today. The gauge closed at a six-month high of 1,061.68 on Feb. 9.

Last week’s inflow into emerging-market stock funds increased the net investment in 2012 to $17 billion, compared with outflows of $11.4 billion for the same period of 2011, Cambridge, Massachusetts-based EPFR Global said in a report e-mailed on Feb. 10.

Morgan Stanley’s Garner reduced his overweight recommendation on emerging-market stocks the same day to 8 percent from 10 percent and advised increasing cash holdings to 2 percent from zero. He maintained his year-end target of 1,210 for the MSCI index, which is about 15 percent higher than the closing level yesterday.

“Strong inflows are a near-term contrarian negative,” Garner said in the Feb. 10 report. “The market is somewhat technically overbought.”

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