Dot-Com Bears Turn Bullish on Emerging-Market BubbleMichael Patterson
Barton Biggs warned of a U.S. stock- market bubble as early as January 1997 and stayed bearish for most of the following three years as the Standard & Poor’s 500 Index surged more than 90 percent to a record.
A decade later, Biggs says another bubble is beginning in emerging-market shares. This time, he’s bullish.
“We’re only halfway along the way to a gigantic eventual bubble in the emerging markets,” Biggs, the managing partner of New York-based hedge-fund firm Traxis Partners LLC and former chairman of Morgan Stanley Asset Management, said in an Oct. 29 interview on Bloomberg Television. “The emerging markets, particularly Asia, are a place where I want to have a really major representation.”
Biggs’s view is shared by Jeremy Grantham, whose investment firm had its assets under management shrink 45 percent in the late 1990s as his pessimistic outlook for high-priced technology stocks spurred clients to buy better-performing mutual funds. The chief strategist at Grantham Mayo Van Otterloo & Co. wrote on Oct. 26 that his forecast for an “emerging emerging bubble” was in “splendid shape” after the MSCI Emerging Markets Index soared 146 percent in the past two years.
While the 49 percent plunge in the S&P 500 from March 2000 to October 2002 proved Biggs, 77, and Grantham, 72, were right to warn of overvalued U.S. shares, their strategy now in emerging markets shows investors are increasingly seeking to profit from bubbles as the U.S. Federal Reserve increases its unprecedented monetary stimulus.
Investment strategists at Bank of America Corp., Credit Suisse Group AG and Societe Generale SA have all said in the past two weeks that emerging-market stocks may climb above levels justified by companies’ assets and earnings because of surging economic growth and the Fed’s efforts to reduce yields on debt securities.
Emerging-market asset prices “may be running ahead of economic fundamentals” as “herding behavior” prolongs the rally, Nouriel Roubini, the New York University professor who predicted the global financial crisis, said at a conference in Cape Town today.
The MSCI emerging-market index rose 1.4 percent yesterday after a report showed China’s manufacturing strengthened and data on American spending and incomes underscored pressure on the Fed to announce more asset purchases this week. The index climbed 0.4 percent to 1,124.74 at 12:27 p.m. in New York.
Investors poured more than $60 billion into emerging-market stock mutual funds in 2010 amid developing-nation growth that the International Monetary Fund says will reach 7.1 percent this year, more than double the 2.7 percent pace in advanced countries, data from Cambridge, Massachusetts-based EPFR Global show. Professional investors are more bullish on emerging markets than any region, according to a Bank of America survey last month of money managers overseeing $492 billion.
“Everyone and his dog are now overweight emerging equities, and most stated intentions are to go higher and higher,” Grantham, who helps oversee about $104 billion, wrote in his quarterly letter to clients posted on the firm’s website. Developing nations’ faster expansion “will give a powerful impression of greater value,” he said.
The MSCI emerging-market index’s 13 percent advance this year has lifted its price to 2.1 times net assets, a record relative to the MSCI World Index of developed-market shares, which trades at a ratio of 1.8, according to weekly data compiled by Bloomberg.
Valuations are the “most stretched” in emerging markets, making them vulnerable to a selloff should global growth disappoint investors, Bob Janjuah, the co-head of cross-asset allocation strategy at Nomura International Plc, said in a Bloomberg Television interview on Oct. 27.
The MSCI emerging-market gauge still trades at a cheaper level than its October 2007 high of 2.9 times net assets, or book value, data compiled by Bloomberg show.
The S&P 500’s price-to-book ratio climbed as high as 5.3 in March 2000 as technology companies including Cisco Systems Inc. and Microsoft Corp. surged on speculation that widespread use of the Internet would cause earnings to soar. Stocks plunged in the next two years and Internet companies including Pets.com Inc. failed.
This year’s best-performing equity benchmark index among major developing nations, Indonesia’s Jakarta Composite Index, has climbed 44 percent and trades for 3.4 times book value, 48 percent more than the average ratio since Bloomberg began compiling the data in September 2001.
The emerging-market index trades at 13.1 times analysts’ estimates for 2010 earnings, a discount to the S&P 500’s ratio of 14, data compiled by Bloomberg show.
Grantham said in his Oct. 26 letter that developing-nation shares will command premium price-earnings ratios in the next few years because of faster economic growth and lower debt levels. He recommended a “moderately overweight” position in emerging-market equities.
Stocks, bonds and currencies in developing nations are likely to climb to bubble levels as the Fed announces another round of bond purchases this week, Michael Hartnett, Bank of America’s chief global equity strategist, wrote in an Oct. 21 report. Hartnett’s scenario, which he called the “most likely” of three outcomes, assumes the Fed will seek to buy $500 billion to $750 billion of debt securities and indicate it’s open to more purchases if needed.
Credit Suisse’s Andrew Garthwaite says the combination of high savings rates, negative real interest rates and rising asset prices has made emerging-market countries including China and India vulnerable to speculative inflows.
“If ever the stage were set for an emerging-market bubble, we think it is now,” Garthwaite, Credit Suisse’s London-based global equity strategist, wrote in an Oct. 27 research report.
Stocks in the biggest developing nations may double as the Fed’s stimulus sends valuations back to their 2008 peak, Dylan Grice, a global strategist at Societe Generale, wrote in a research report e-mailed Oct. 22. Buying call options on emerging-market equities may be a cheap way to profit from a “nascent” bubble, Grice wrote.
Investors use options to guard against fluctuations in the price of securities they own, speculate on share-price moves or bet that volatility, or stock swings, will rise or fall. Calls give the right to buy a security through a specific date for an agreed price.
“The headache posed by bubbles depends on the asset managers’ perspective,” wrote Grice, who is based in London and was ranked the No. 2 strategist behind SocGen’s Albert Edwards in Thomson Extel’s Pan-Europe 2010 survey. “For skeptics the pain is on the way up, for true believers it’s on the way down.”
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