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Emerging market fund flows a mirage?

Emerging market fund flows a mirage?
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First Published: Mon, Nov 12 2007. 12 18 AM IST
Updated: Mon, Nov 12 2007. 12 18 AM IST
Emerging markets are traditionally the first casualty of financial turmoil. But not this time.
During September and October, while developed world investors were grappling with the effects of the credit crunch, emerging market equities stormed ahead 23%, according to Merrill Lynch & Co. Inc.—the largest two-month surge since March-April 1999. There have also been eye-popping initial public offerings from PetroChina Co. Ltd and Alibaba.com Corp. Meanwhile, emerging market bond spreads have narrowed to just 2% over US treasuries, compared with more than 10% a few years ago.
Much of this surge is driven by a tide of money from global investors looking to escape the stricken US economy. In the last 10 weeks, the inflow into emerging market equity funds has been $34 billion (Rs1.34 trillion)—more than the annual totals for 2005 and 2006. Hedge funds and private equity firms are also pouring money and resources into emerging markets. Emerging markets account for 83% of the world’s population, 55% of its gross domestic product at purchasing power parity and just 22% of its market capitalization, and even that falls to just 11% when adjusted for free floats, says Merrill Lynch.
What’s more, a decade after their economies were crushed by the Asian crisis, most emerging markets now boast vast currency reserves, huge trade surpluses and diversified economies. That has made many emerging markets better credit risks than some developed countries.
Still, investors are taking two big bets. First, whether emerging market economies have truly “decoupled” from the rest of the world. A growing proportion of their rapid growth is driven by domestic consumption and intra-regional trade. But there are still question marks over how resilient this growth will prove in the teeth of a sharp US slowdown and slump in global commodity prices.
The second bet is investors can deploy all these funds profitably. Even those comfortable with the long-term prognosis might baulk at current emerging market stock valuations.
At the end of October, emerging markets traded on a price earnings ratio of 14, well ahead of their 10-year average of 10 times, and pretty much in line with the FTSE world market index. Investors would have to believe that emerging market growth over the next two years will be unabated. That said, so long as liquidity keeps flooding into these markets, the emerging bubble will continue to inflate.
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First Published: Mon, Nov 12 2007. 12 18 AM IST