Emerging markets are on a tear. Global jitters normally hit riskier assets, but far from sliding on fears over the impact of the credit crunch, the MSCI Emerging Markets index has gained around 13% in dollar terms over the past three months, eclipsing developed markets and hitting new peaks. Investors are, “incredibly, seeking refuge in emerging markets” from the subprime crisis, says Liam Halligan in The Sunday Telegraph.
Net inflows into emerging market equity funds hit an 85-week high in late September, according to EPFR Global. Investors are fleeing to safety by moving money away from the US and Europe, where banking systems have the greatest exposure to subprime-linked debt, says Cameron Brandt of EPFR. The flight to safety has also been spurred by strong developing world growth, expected to total about 8% this year, with India, China and Russia accounting for half of global growth, according to the IMF. Investors hope emerging economies can decouple from an ailing US and keep the global economy ticking over.
India is particularly popular at present, having raked in a net $13.6bn from global investors in 2007, compared to $8.9bn for the whole of last year. The Sensex index is now up almost sixfold over the past five years and 20% in three months. Apart from its software and outsourcing firms, its blue chips, unlike many big firms across Asia, aren’t dependent on exports, as Eric Bellman notes in The Wall Street Journal. Exports comprise under 15% of GDP.
What’s more, overall growth is likely to be underpinned by rate cuts over the next few months, which should offset a slowing global economy, reckons Prasenjit Basu of Daiwa Securities, who sees GDP growth edging up to 9.5% in the year to March 2009. Consumption is humming as the new middle class expands, with over half the population expected to have a mobile phone by 2015, compared to just one-sixth at present. Along with huge long-term potential, India boasts some of the world’s best-run and most profitable companies.
Prices are looking historically high, with the Sensex on 20 times this year’s earnings and 18 times next year’s, according to Assif Shameen in Barron’s. However, Citigroup says earnings are set to expand by 17% in both years, and many fund managers reckon impressive earnings growth will help maintain enthusiasm. Samir Arora of Helios Capital Management thinks there is scope for another 15% appreciation by the Sensex this year. But given the latest sharp run-up, the market appears vulnerable to a setback. This is the “excitement before the climax”; there is “a huge correction coming”, one broker told the Pakistan Times.
The threat of a slide following the latest rush applies to emerging markets in general. In the long-term, these markets “have to deliver” as the East gradually outstrips the “indebted, sluggish West”, says Halligan. But when investors everywhere have the same idea – flee to emerging markets to escape subprime slime – prices “simply have to overshoot”. This “bubble-like” increase is likely to be followed by a sharp slide in the MSCI index.
Note too that emerging markets are now trading at a slight premium to developed markets, even though decoupling has yet to be tested in earnest and developing markets have become more highly correlated with the rest of the world. So they are hardly likely to remain unscathed if further jitters hit Western markets. As Lex put it in the FT, “investors should look elsewhere for a safe haven”.