Boom in Emerging Markets Has Some Fearing Backlash
By TOM LAURICELLA
The Federal Reserve's latest effort to juice the U.S. economy is making many investors in emerging-market and commodity-producing nations confident the rally has longer to run.
Others see trouble ahead, concerned too many investors are jumping into the rally and that these markets can't keep rising if the U.S. economy stays sluggish.
The Fed's easing through expected purchases of U.S. government debt suggests "this emerging market boom has room to run for a while," says David Rolley, global investment strategist at mutual-fund company Loomis Sayles.
Already this year, a record $60 billion has gone into emerging-market stock and bond funds, according to EPFR, which tracks money flows globally.
Investors expect the Fed to spend at least $500 billion in its so-called quantitative-easing effort, and that money will likely find its way into other markets, particularly emerging markets, which offer higher yields and prospects for asset-price growth. And the dollars being pumped in will only serve to devalue the U.S. currency further.
Investors are betting that Asian and Latin American nations will remain largely powerless to prevent the rise of their currencies against the U.S. dollar, even with capital controls and other efforts to stem the tide of money or push down their currencies.
Mr. Rolley likes Mexico's bonds. He says that even though yields on peso-denominated bonds are at record lows, the trade "is not that crowded yet." Eric Stein says he and the other portfolio managers on the Eaton Vance Global Macro Absolute Return fund have been betting on gains in currencies from Indonesia, Malaysia and South Korea.
But even bulls acknowledge betting on emerging markets is a "crowded trade." With so many investors jumping on the bandwagon, others see trouble ahead for these markets should the U.S. economy stay sluggish.
"Whenever you have a view that's similar to other people, it's cause for concern," says Eaton Vance's Mr. Stein.
Currencies would have risen more if they had been allowed to, he says, "but the Asian central banks have been leaning against the wind…and prices have not been allowed to move as fast as they otherwise would."
At Allianz SE's Pacific Investment Management Co., or Pimco, Ramin Toloui, co-head of emerging markets, says his bias is to favor bonds issued in local currencies, where investors would also get a boost from any rise in the issuing nation's currency.
"Implicit in this is the view that the effectiveness of emerging-market countries to resist currency appreciation will be limited," Mr. Toloui says.
Big currency moves have come just since late August, when Fed Chairman Ben Bernanke first signaled more easing was possible. The Australian dollar has gained more than 11% against the U.S. dollar since Aug. 26. On Friday, as Mr. Bernanke reiterated that he was prepared to start a new round of easing, the Aussie briefly reached parity for the first time since it was floated in 1983.
Potentially more fuel for this fire would be China succumbing to international pressure and allowing its currency to rise faster against the U.S. dollar.
Investors believe more flexibility by China could translate into bigger gains for other countries in that region, such as Singapore and South Korea, because their relatively weaker currencies would help their exports rise. Some are looking to the Group of 20 meetings in South Korea for signs bigger moves in the yuan are in store. The yuan is up 2.7% since June against the dollar, most of that move coming in the past month.
The widespread bullish outlook for emerging markets contrasts with general caution in the U.S. stock and Treasury-bond markets, which may have largely factored in the impact of additional quantitative easing.
The Dow Jones Industrial Average has gained more than 10% since Aug. 26, ending last week at 11062.78. But many investors appear skeptical of the Fed's efforts to provide a substantial lift to the U.S. economy.
If that turns out to be the case, it suggests there will be little additional meaningful benefit from the easing for stocks, especially if individual investors continue to flee. They have already drained U.S. stock funds of nearly $80 billion since the beginning of May, according to the Investment Company Institute.
David Woo, head of global currency research at Bank of America Merrill Lynch, believes the Fed's efforts to boost the economy will fall flat and that the consequent stalling of the U.S. economy will lead to slowing of emerging-market growth. Nearer term, Mr. Woo doesn't expect China to allow the yuan to appreciate any faster. He argues that after the G-20 meetings, "the short-dollar, long-Asia positions will become vulnerable."
There are risks to the consensus bullish view on emerging markets. In the short term, there remains the possibility of a backlash among emerging-market economies against the flood of money into their markets. Last week, Thailand, which has seen its currency rise nearly 6% against the dollar since late August, imposed a 15% tax on income that foreigners earn from Thai bonds.
John Normand, currency strategist at J.P. Morgan, sees little likelihood of a coordinated effort to allow an appreciation of emerging-market currencies including the Chinese yuan against the dollar.
"It's not going to be a smooth process," he says.
Still, Mr. Normand says, "when we look back on this in six months, we'll find the dollar is weaker against Asian currencies."