“All major bubbles have been fuelled by easy money,” says Citigroup. And now money is “excessively easy”. Banks have slashed interest rates and printed money to stave off a slide into deflation. Globally, real interest rates are at historic lows and have been negative for three quarters. And the easy-money phase is set to endure “at least until the second half of next year”.
But where will the liquidity resulting from this largely Western pump end up? Money tends to flow “to the best investment stories”, says Christopher Wood of CLSA. These days that means emerging markets. “There is a real possibility” of an asset bubble developing in Asian and emerging equities.
Emerging markets have matured
Emerging markets “have come of age”, says Tim Price of PFP Wealth Management. Last year, for the first time, the developing world consumed more energy than the developed world. But it’s not simply a question of gradually increasing economic muscle: emerging fundamentals are better. Developing economies, notably Asia’s, have younger populations as well as larger foreign-exchange reserves, making them more resistant to crises.
A league table of total private and public-sector debt levels shows that industrialised nations take the first nine spots, says Price. Japan tops the list, with total debt at 370% of GDP and Israel the worst emerging nation with 170% of GDP; in most cases the total is under 100% of GDP.
In most of Asia, household debt is less than 50% of GDP, compared to over 100% in many developed economies; in India the figure is under 15%. Throw in the fact that Asia ex-Japan’s private consumption last year reached around 40% of American levels and there is ample scope for consumer spending to rise over the long term, offsetting the region’s reliance on exports. Banking systems also look much healthier and corporations are far less leveraged than their developed counterparts. Meanwhile, Western nations are set to struggle for years as they work off their debt loads.
In future, then, “investors will be hard-pressed to find fundamental reasons to buy knackered, ex-growth, largely insolvent economies such as Western Europe’s, when they can buy healthy, pro-growth solvent economies in the so-called developing world”, says Price. And while emerging markets are up 50% from their October lows, says Citigroup, this is “just a fraction” of the gains seen in previous bubbles. They trade on 1.8 times price/book ratios, in line with the long-term average.
But they won’t rocket just yet
But while there is plenty of scope for a mania to develop as investors increasingly focus on developing countries’ appealing long-term outlook, emerging markets’ near-term future looks likely to be bumpy. In Asia, for instance, the worst appears to be over, but the rapid rebound investors are hoping for seems unlikely. As Capital Economics points out, tight credit is hampering domestic demand and “this time around Asia will get far less help from the global economy than in the 1990s”. Meanwhile, the Asia ex-Japan rebound looks overdone as earnings forecasts are too optimistic, says Markus Rosgen of Citigroup.
Moreover, the global recovery is likely to disappoint, and another bout of global jitters would dent emerging markets too. “We would not chase” emerging stocks over the summer, says Morgan Stanley. Eastern Europe is especially vulnerable to renewed global risk aversion, given its shaky banking sector and worries over contagion from a devaluation in Latvia, adds Capital Economics. Don’t expect the mania to kick in just yet.