Emerging Markets: the love story

February 14, 2012

It is Valentine’s day and emerging markets are certainly feeling the love. Bank of America/Merrill Lynch‘s monthly investor survey shows a ‘stunning’ rise in allocations to emerging markets in February. Forty-four percent of  asset allocators are now overweight emerging market equities this month, up from 20 percent in January — the second biggest monthly jump in the past 12 years. Emerging markets are once again investors’ favourite asset class.

Looking ahead, 36 percent of respondents said they would like to overweight emerging markets more than any other region, with investors saying they would underweight all other regions, including the United States. Meanwhile investor faith in China has rebounded  with only 2 percent of investors believing the Chinese economy will weaken over the next year, down from 23 percent in January. China also regained its crown of most favoured emerging market in February.

Last year, the main EM index plummeted more than 20 percent as emerging assets fell from favour. So what is the reason for this renewed passion in 2012?

Firstly December’s LTRO — a multi-billion euro liquidity arrow from the cupids at the ECB has revived investor appetite for riskier emerging assets, boosting the index to around six-month highs since the start of the January. A second significant factor behind the resurgence in  risk sentiment is that the market is daring once again to hope for an improvement in global growth, says Gary Baker,  BofAML Global Research head of European equities strategy.

The big beneficiaries of all this have been emerging markets.  It’s not just about liquidity. Clearly the actions of the ECB have been vitally important… but what you’ve also seen is an improvement in global growth optimism. If optimism over growth is improving  then there may well be a more fundamental underpinning to the movement.

So is investors’ new-found love for emerging assets a passing flight of fancy or a true sign of commitment?

The significant monthly improvement  in market sentiment towards emerging markets  and the 44 percent level of investors overweight emerging markets are both events which have historically coincided with short-term underperformance by emerging equities, Baker says.

In the past, moves of that scale and typically  emerging markets at those levels have been very close to contrarian triggers of underperformance. That’s what you’re always trying to judge within this: how far consensus has moved, how quickly it has moved and whether it has got too far instead of itself.

While the second ECB liquidity injection at the end of February will provide a further aphrodisiac for investors, robust risk appetite in the longer term will need concrete signs of global growth rather than just optimism over the global economic outlook, Baker says.

Another round of forecast-beating global data would pick off those investors who are wavering on the edge. If people have not participated yet, they’re not going to change their minds unless their global growth view changes.  It’s about actual data coming through and challenging the existing consensus of a mild recession in Europe, an okay outlook in emerging markets and suboptimal U.S. growth. Changing that would really trigger a full-on risk-on rally.

(By Alessandra Prentice)

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