Emerging Markets: Bubble or Growth Leader?By
Federal Reserve Chairman Ben Bernanke has tried everything to feed the U.S. economy the liquidity it needs to revive. In the process, he has conjured up more than $1 trillion of fresh monetary stimulus out of thin air. Inevitably, much of it has ventured overseas in search of yield. The big beneficiaries have been the stock markets of the emerging-market economies. Since its low in March 2009, the MSCI Emerging Market Index is up 135 percent, vs. 75 percent for the Standard & Poor's 500-stock index. While the two indices have roughly the same price-earnings ratios, the discrepancies in performance are striking.
Many investors now worry that the ardor for emerging markets will destabilize the global economy. Others see a long-overdue rebalancing. The question: Should investors double down or stay the hell away?
It's the emerging emerging-market bubble debate of 2010. A case can be made that emerging markets have gotten way ahead of themselves. The week ended Oct. 20 saw record inflows to emerging-market mutual funds and exchange-traded funds. The $68.5 billion invested so far this year is on pace to shatter last year's record $83.2 billion, reports market researcher EPFR Global. "While improved risk appetite is to be welcomed, one proviso is just how narrow the investor focus on emerging equities is at this point," wrote Michael Hartnett, chief global equities strategist at Bank of America Merrill Lynch, (BAC) in an Oct. 20 note.
The hunger for emerging-market investments is more striking from a historical perspective. In 1990, eight emerging-market equity funds had a combined $380 million in assets, according to Morningstar (MORN). Now 288 funds manage $365 billion. "What happens when you have a compelling investment case and too much liquidity? You get rampant asset price inflation," wrote Dylan Grice, a London-based global strategist at Société Générale, on Oct. 22. "Bubbles always start with a compelling story. Emerging markets are the compelling story du jour."
Believers in a new era are more sanguine. "Emerging markets get a lot of performance-chasing," concedes Lawrence Weinman, a Los Angeles investment adviser. "But I do think that beneath the hot money flows there is a growing realization that the relative economic growth in the world just won't be in the States." Weinman says the investors he works with are changing their allocation models to commit more to China, Brazil, India, and other fast-growing markets.
Consider, for example, how far China has come vs. how far it has left to go. According to economic research firm GaveKal, 90 percent of Chinese exports come from just 9 of its 31 provinces. The other 22 now have a voracious demand for road, rail, and air infrastructure. Low interest rates in the West, says GaveKal, will disproportionately benefit the developing world because there is more opportunity for investment growth. According to Bloomberg and the International Monetary Fund, China's economic output may exceed 10 percent of the world's total within two years, compared with 2 percent in 1987. The Group of Seven developed nations—the U.S., Japan, Germany, Canada, Italy, the U.K., and France—are tracking to produce less than half of global output by 2012, compared with 70 percent in the mid-1980s.
Bubble or not, developing economies are struggling with their newfound riches. "They are not desperate for capital inflows, and currency appreciation is hurting their exports," says Ravi Ramamurti, director of the Center for Emerging Markets at Northeastern University.
Colombia, whose main stock index is up 50 percent this year when translated into dollars, is considering capital controls to stem its peso's runup. Thailand's baht is at a 13-year high; its government is mulling a tax on foreign gains made on its bonds. This month Brazil twice raised taxes on foreign investors to guard its exports from what Finance Minister Guido Mantega called a global currency war.
If only the world could be inherited on the installment plan.
The bottom line: Investors are divided between those who predict an emerging-market bubble and those who see a permanent shift in global equities.