The return of risk appetite4 min read . Updated: 05 Apr 2009, 10:40 PM IST
The return of risk appetite
The return of risk appetite
So what recovery are we talking about? Well, the MSCI Bric Index is up 11.55% this year and the Emerging Markets Index is higher by 9.43% (all data in local currency terms). MSCI India is higher by 9.47% since the beginning of the year and MSCI Korea is up 14.51%. Even the Emerging Frontier Markets Index, composed of countries with underdeveloped stock markets in Eastern Europe, Africa and West Asia, is up 8.29% this year. The developed and emerging markets have decoupled, indicating the return of risk appetite.
Also See Gaining Strength (Graphic)
MSCI Indices (Graphic)
That is corroborated by data provided by EPFR.com, the global funds flow tracker. Global emerging market equity funds saw net inflows of $4.5 billion (Rs22,635 crore) in the first quarter of 2009, compared to a net outflow of $6.6 billion in the same quarter last year. Asia ex-Japan funds did see modest net outflows of $889 million, but that’s much lower than the $12 billion that flowed out in the first quarter of 2008. And although funds targeting Emerging Europe saw large net outflows, the fact remains that emerging market equity funds as a whole saw net inflows of $3.2 billion in the March quarter, compared with outflows of $20 billion in the same quarter of 2008. As EPFR Global managing director Bill Durham put it: “While flows out of funds geared to US and Japan Equity Funds are actually worse on a percentage of assets under management basis compared with Q1 08, flows into emerging markets equity funds have swung from deeply negative to positive."
It isn’t just the stock markets that have gone up. Bond spreads on emerging markets have improved, with the JP Morgan EMBI+ Index showing that spreads over US treasuries have fallen to around 580 basis points compared to the near 700 basis points spreads at the beginning of the year. Credit default swap spreads on emerging market debt have come down. In the developed markets, measures of volatility such as the US Vix Index have eased, as has the London inter-bank offered rate, a measure of how much banks charge each other for loans.
Economic data also seems to suggest a bottom may be in place. The JPMorgan Global All-Industry Output Index, a survey-based composite measure of conditions in both the manufacturing and service sectors globally, rose to a five month high of 40.1 in March from 37.4 in February. Commenting on the survey, David Hensley, director of Global Economics Coordination at JPMorgan, said: “Output and new orders indexes for both manufacturing and services tracked higher in March. Although nowhere near levels consistent with outright recovery, it suggests that the fall in global GDP expected for Q2 will be markedly slower than in Q1 2009 and Q4 2008." In China, the official Purchasing Managers’ Index for manufacturing showed that manufacturing expanded in March, with a reading above 50 for the first time since last September. Chinese loan growth continued to dazzle last month.
At the same time, it’s important not to cherry-pick the data. The CLSA Chinese PMI for March, for example, showed that manufacturing contraction deepened in March. The decline in the US services sector accelerated during the month. Several economists have warned that the Geithner plan for purging toxic assets off bank balance sheets may not work. Global trade indicators continue to show sharp contraction. And financial institutions such as the World Bank and the International Monetary Fund have said the world economy will shrink this year and the recovery in 2010 will be tepid.
Also, while it’s true that there has been an improvement in risk appetite, the EMBI+ spread is still much higher than the levels of around 300 basis points or so before the Lehman Brothers Holding Inc. collapse hit the markets. Consider also that, despite all the quantitative easing in the US, Moody’s yield on BAA rated US corporate bonds (a measure of rates for second-rung firms) currently stands at around 8.4%, higher than the 7% or so yields at the beginning of last September. Similarly, while the US Vix has slipped below 40, it was in the mid-20s in early September.
But then nobody expects the recovery to be swift. All that the markets have started pricing in is, in the words of a research report by Barclays Capital, the “end of the free fall". The authors of the report point out that all that is happening is that the speed of the downturn is slowing and the slew of negative surprises is starting to reduce, although they agree the recovery is likely to be feeble and that balance sheet constraints are going to constrain credit for a long while.
So what does all this mean for markets? Says Barclays Capital: “We believe the more balanced distribution of risks we are envisioning for the next quarter (Q2 of 2009) is consistent with a moderate reduction in risk premium. Financial markets have been pricing a non-negligible probability of a severe depression or at least a very long recession.
To the extent that scenario becomes less likely as the global economy (particularly the US, given its disproportionate effect in setting the price of risk) finds a floor, we believe the global risk premium will continue to fall. At the same time, the bounce would most likely be more modest than in previous recoveries, given our view of a slow economic recovery towards a growth potential already severely eroded by the crisis."
Graphics by Ahmed Raza Khan / Mint
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