Emerging Markets Most Costly Since ‘07 on Fund Flood by Bloomberg

I believe that this article sums up my view I have on the market. Interesting perception on funds flow.

Emerging Markets Most Costly Since ‘07 on Fund Flood (Update2)

By Patricia Lui and Michael Patterson

June 2 (Bloomberg) -- The four-week flood of money into developing-nation stock funds that drove the MSCI Emerging Markets Index to an eight-month high is sending the strongest sell signal since equities peaked in October 2007.

Inflows totaled $12 billion, or 3.5 percent of developing- nation fund assets, the most since the 22-country benchmark hit its record high 19 months ago, said EPFR Global, which tracks $10 trillion in investments worldwide. The only other time since 2001 that funds attracted as much cash, in February 2006, the MSCI gauge lost 8.4 percent in four months.

The pattern signals an “imminent” drop after the MSCI index’s 3.8 percent rally yesterday pushed its advance since February to a record 61 percent, according to Michael Hartnett, a Bank of America-Merrill Lynch strategist who predicted this year’s gains in Chinese, Brazilian and Russian shares. A slower- than-estimated economic recovery in China, the largest emerging market, may spark a retreat, said RBC Capital Markets.

“Fund flows at their extremes are contrary indicators,” Leo Grohowski, who helps oversee about $132 billion as the New York-based chief investment officer at BNY Mellon Wealth Management, said in an interview. “We’re looking for some consolidation.”

BlackRock Inc., the biggest publicly traded asset manager in the U.S., and Aberdeen Asset Management Plc, Scotland’s largest independent money manager, also are forecasting a downturn after the MSCI index’s price-to-earnings ratio almost doubled this year. The gauge trades for 15.2 times reported profits, the most expensive level since December 2007, according to weekly data compiled by Bloomberg.

Doubting the Rally

The MSCI index slid 1.3 percent to 791.82 at 8:48 a.m. in London, the steepest decline since May 21.

“Investors are starting to doubt the sustainability of how much longer this very sharp rally can continue without a pullback,” said Brad Durham, the co-founder and managing director at Cambridge, Massachusetts-based EPFR Global. “Valuations are not as attractive.”

The MSCI measure dropped 48 percent in the second half of 2008, while emerging-market bonds lost 18 percent and every major currency except China’s yuan retreated against the dollar. Treasuries returned 11 percent in the same period as investors sought the highest-rated assets, according to Merrill Lynch’s U.S. Treasury Master Index.

2009 Rebound

More than $12 trillion pledged by the U.S. government to ease the global recession, along with $1 trillion of aid from international organizations to bolster developing economies, prompted investors to reverse their trades this year. The MSCI emerging-market index’s rally the past three months was the biggest since its inception in December 1987 and beat the 29 percent rise in the MSCI World Index of developed-nation shares.

The dollar lost 2.7 percent against a basket of six major currencies this year, while U.S. government securities dropped 4.3 percent through last week in their worst annual start since Merrill began tracking returns in 1978.

HSBC Private Bank’s Arjuna Mahendran said the surge in emerging-market equities may last another six months as faster economic growth in developing countries prompts investors to keep shifting out of lower-yielding assets.

Developing nations will grow 1.6 percent as a group in 2009 and 4 percent next year, according to the Washington-based International Monetary Fund, which was formed after World War II to help stabilize member countries’ economies. That compares with IMF estimates for a 3.8 percent contraction in developed economies this year and no growth in 2010.
Money-Market Funds

Yesterday’s rally in emerging-market stocks was sparked by a report showing Chinese manufacturing grew for a third month in May, fueling speculation the world’s third-largest economy is recovering.

Bullish money managers say that emerging-market stocks will keep gaining as investors shift some of the $3.8 trillion in money-market funds into equities. The funds, which aim to preserve capital without targeting high returns, hold about 60 percent more assets than the average this decade, according to the Washington-based Investment Company Institute.

“There’s a lot of money looking for decent returns and that’s going to continue driving emerging markets,” said Mahendran, the Singapore-based chief investment strategist for Asia at HSBC Private Bank, which oversaw $352 billion as of the end of last year. “They are the only place on earth where any growth is taking place.”

‘Bubble-Like’ Rush

Merrill’s Hartnett said the long-term outlook for gains in developing-nation economies and equities may not warrant the “bubble-like” rush into emerging-market stocks the past few months. For Jonathan Garner, a Morgan Stanley strategist, the surge in fund flows shows a “euphoria” among investors seen before previous market peaks.

Investors poured $19 billion into emerging-market stock funds in the four weeks to Oct. 17, 2007, EPFR data show. The MSCI gauge began tumbling from a record 1,338.49 two weeks later, losing as much as 22 percent during the next four months.

Garner, Morgan Stanley’s London-based head of Asian and emerging-market strategy, is advising clients to reduce holdings of stocks from developing countries to buy later at lower prices.

Even though developing-nation economies are expanding, earnings at companies in the MSCI emerging-markets gauge trailed analysts’ estimates by an average of 41 percent in the first quarter, a wider miss than the 6.7 percent average in MSCI’s developed markets gauge, Bloomberg data show.

Stalled Recovery

Analysts predict shares in the emerging index will fall 2.9 percent in the next 12 months on average, compared with a 3.4 percent gain for developed markets, according to estimates compiled by Bloomberg.

China’s economic recovery began to stall in the second half of April and slowed further in May, raising concern that the rebound won’t be as “strong as many recently have hoped,” Dong Tao, Credit Suisse Group AG’s Hong Kong-based economist, wrote in a report last month. He cited weaker electronics and retail industries and a slump in power consumption.

While the expansion in China’s manufacturing suggests an economic rebound in the second half of this year, investors shouldn’t expect a “straight-line” recovery, said Nick Chamie, the global head of emerging markets research at RBC in Toronto. Lower exports and a delayed increase in Chinese consumer spending may spur “mixed” economic data in the coming months and cause declines in emerging-market assets, he said.

China stock funds attracted the most money among the biggest emerging markets this year, taking in $3.6 billion. That compares with the $2.8 billion added into Brazilian funds, $483 million into India and $410 million into Russia, the three other biggest developing-nation economies, the EPFR data show.

China Stimulus

Investors lured to China by the government’s 4 trillion yuan ($586 billion) stimulus package spurred a 49 percent rally in the benchmark Shanghai Composite Index this year. The gauge trades for 21 times analysts’ estimates for 2009 earnings, the second-highest among major emerging markets worldwide after Taiwan, according to Bloomberg data.

BlackRock, which oversees about $1.3 trillion, pared holdings in China and Taiwan this year on concern prices rose too fast, said Bob Doll, the New York-based money manager’s vice chairman and global chief investment officer of equities. Emerging markets may lead a “correction,” or decline of about 10 percent, in stocks worldwide before recovering later this year, he said.
Aberdeen Managing Director Hugh Young is selling some financial stocks and buying “defensive” shares including Jakarta-based tobacco company PT BAT Indonesia on expectations companies with stable revenue will outperform during a selloff.

“Stock markets have rallied too strongly,” said Young, who helps oversee about $35 billion of Asian assets for Aberdeen in Singapore. “We are far from being out of the woods.”

To contact the reporters on this story: Patricia Lui in Singapore at plui4@bloomberg.net; Michael Patterson in London at mpatterson10@bloomberg.net.
Last Updated: June 2, 2009 04:19 EDT