Risk appetite is back, and with it, the search for yield in emerging markets.
According to the WSJ, US investors have pumped roughly $26bn into emerging-markets funds this year, $15bn of which was invested via exchange-traded funds.
All well and good. But as the search for yield intensifies, so do fears that a global bubble is forming afresh.
Note the following from Variant Perception’s report last month, which aptly explained the thinking:
Emerging markets are a very small part of total world equity capitalization, despite being a significant part of total world GDP. As investors seek exposure, they will overwhelm small markets. The expansion of monetary bases in western countries will also leads to the outperformance of emerging markets. We take a closer look at some of our favoured emerging markets: Brazil, Turkey and China.
The Variant analysts also highlighted the likely effects of central bankers’ deflationary fears:
As we have said before, it is precisely the deflationary fear - the fear of the liquidity trap - that will drive central banks to be extremely loose with their monetary policies. Central banks are afraid of the fall in monetary velocity, and because of this we believe they will continue to flood the world with money until they are convinced velocity will rise. This will lead to asset bubbles around the world. But not all assets will inflate at the same time or the same pace. Some bubbles will be isolated, others will occur simultaneously; some will spread by contagion, and others will be congenital. As we have stated before, this process does not fit a ‘black-or-white’ debate about inflation or deflation.
Schroders’s chief investment officer Alan Brown echoed Variant’s concerns on Monday. As Reuters reported, Brown told reporters:
“Our concern today is that with the developed world having had its crisis and now that we have extraordinarily easy money here, that may be providing the fuel for an asset bubble in the emerging markets,” he said. “And there are some signs that’s beginning to happen.”
Of course, one region signalling more bubble alarms than most is China.
FT Maverecon blogger Willem Buiter warned back in October this was because much of the country’s record stimulus spending had been misdirected — from a structural or sectoral perspective — even if it met the short-run cyclical objective of boosting demand.
This meant, as he put it, that China was creating massive excess capacity in export-oriented industries, and that:
The bank loans that financed these misdirected expenditures will go belly-up before long with a high probability.
In Buiter’s eyes, China had put all its eggs in just one basket: the hope that international demand for its exports would return in the not too distant future.
And herein lies the risk. Some, like RBC’s Nigel Rendell, are optimistic China will be successful at bridging the gap - that its spending will sustain the country until the rest of the world recovers. Others, like Buiter, are concerned that unless the composition of both its domestic demand and domestic production are changed towards consumer goods and non-traded goods and services, credit and asset market dysfunctionality may be the lone result.
Such market dysfunction would, by the way, only be increased if currency controls were lifted.
As Variant Perception concluded:
If these controls were relaxed, however, and the currency allowed to freely fluctuate, then all bets are off as to the effect on Chinese markets. This would be no different to Japan by the 1980s when most restrictions on capital accounts were opened up and the yen was allowed to float. Indeed many if not all of the bubbles that have occurred since the Dutch Tulip Mania in the 17th century have been precipitated by a combination of financial liberalization and innovation.
Related links:
UBS, the bubble-talk bashers - FT Alphaville
Asset bubble warnings, international monetary institution edition - FT Alphaville
China is `the most obvious area of concern’, Fitch says - FT Alphaville
