True, bonds from all classes of emerging market have benefited from the flood of money flowing from central banks in the United States, Europe and Japan, with over$20 billion flowing into EM debt funds since the start of 2013, according to EPFR Global. Flows for the first three months of 2013 equated to 12 percent of the funds’ assets under management.

But the effect has been most marked in emerging European local currency bonds — unsurprising, given economic growth here is weakest of all emerging markets and central banks have been the most pro-active in slashing interest rates.  Emerging European yields have fallen around 50 basis points since the start of the year, compared to a 20 bps average yield fall on the broader JPMorgan index of emerging local bonds, Thomson Reuters data shows.

The IMF today advised Poland to continue cutting rates “without delay” to boost the economy. That should give another leg-up to zloty bonds, where short-dated yields are already at record lows.

The flows have also been a boon to troubled countries such as Hungary that might otherwise have scrabbled for money. Instead, Budapest had by end-April fulfilled more than 65 pct of its 2013 funding needs and has since indicated it might not need to tap international bond markets again this year.

But the catch is that the central bank money-printing won’t last forever, with Fed officials already hinting at tapering off the $85 billion a month asset purchase programme. Once that happens, a stronger dollar and higher U.S. yields are inevitable. Both have always spelt bad news for emerging assets and this time will be no different.

In the local currency debt space, central Europe is possibly most vulnerable to an investor exodus.  An RBS index of 10-year bonds from central Europe, Middle East  and Africa is currently yielding 4.75 percent. That’s almost a 300 basis-point premium over Treasuries.  But note: the average for the GBI-EM index is 5.2 percent. RBS analysts ask at what level of bond yield will flows begin to dry up? They say:

If it is yield differentials with developed markets, then a lot more. If we use real yields as reference and if past inflation is any use, then most countries already pay zero or negative real yields. That makes CEEMEA bonds already expensive. 

They note however:

Expensive is not a “relevant” word when faced with a wall of money. It is making money that is relevant.

As Citi’s chief executive famously said at the height of the pre-crisis markets boom, as long as the music plays, you’ve got to get up and dance.  The  music is of a different kind these days, but it is still playing. And for now, investors are still dancing.

And as Draghi returns 10 months on, there’s little doubt that he and his U.S. and Japanese peers have succeeded in convincing financial investors of central bank doggedness at least. Don’t fight the Fed and all that – or more pertinently, Don’t fight the Fed/BoJ/ECB/BoE/SNB etc… G4 stock markets are surging ever higher through the Spring of 2013 even as global economic data bumbles along disappointingly through its by now annual ‘soft patch’.  Looking at the number tallies, total returns for Spanish and Greek equities and euro zone bank stocks are up between 40 and 50% since Draghi’s showstopper last July . Italian, French and German equities and Spanish and Irish 10-year government bonds have all returned about 30% or more. And you can add 7% on to all that if you happened to be a Boston-based investor due to a windfall from the net jump in the euro/dollar exchange rate. What’s more all of those have outperformed the 25% gains in Wall St’s S&P 500 since then, even though the latter is powering to uncharted record highs. And of course all pale in comparison with the eye-popping 75% rise in Japan’s Nikkei 225 in just six months!! Gold, metals and oil are all net losers and this is significant in a money-printing story where no one seems to see higher inflation anymore.

But with both Fed and BoJ pushes getting some traction on underlying growth and the euro zone economy registering it’s 6th straight quarter of contraction in the first three months of 2013, maybe Draghi’s big task now is to convince people the ECB will do whatever it takes to support the 17-nation economy too and not only the single currency per se. Last year’s pledge may have been a necessary start to stabilise things but it has not yet been sufficient to solve the economic problems bequethed by the credit crisis.

Coincidence or not, Draghi speech on Thursday is flanked by keynotes from his monetary allies. Fed chief Bernanke  speaks on Saturday and then to testifies to the congressional Joint Economic Committee on Wednesday, BoJ head Kuroda holds a press conference after the bank’s policymaking meeting ends on Thursday and outgoing BoE governor King speaks Friday. G20 sherpas meet in Russia this weekend, while EU leaders meet in Brussels on Wednesday. The big economic data set-piece of the week will be critical flash global PMI readings for May – is business finally pulling out of the early year funk or is confidence still evaporating?

Main economic events and data releases for next week:

G20 sherpas meeting in St Petersburg Sat/Sun

Fed’s Bernanke speech on long-run economic prospects Sat

Italy March Industry orders Mon

Irish PM Kenny in Boston Mon

Japan 40-yr JGB auction Tues

UK April inflation Tues

Japan April trade Weds

BOJ news conference after latest policy meeting Weds

BoE minutes Weds

EU summit Weds

German 10-yr bund auction Weds

US April existing home sales Weds

Fed’s Bernanke testifies to Joint Economic Committee of Congress Weds

FOMC minutes Weds

Global May flash PMIs Thurs

Spain govt bond auction Thurs

UK April retail sales/Q1 GDP revision Thurs

ECB’s Draghi speaks in London Thurs

EZ May consumer confidence Thurs

US April new homes sales/March house prices Thurs

SAfrica rate decision  Thurs

German May Ifo sentiment Fri

French May business climate Fri

Italy May consumer confidence Fri

US April durable goods orders Fri

BoE’s King speaks in Helsinki Fri

In terms of growth and profit, the banking sectors in the CEE (central and eastern Europe) region continue to outperform their Western European counterparts.

Real loan growth in the region’s banks, which includes Russia and Ukraine, was 21.8 percent between 2010 and 2012, Raiffeisen says, while euro zone banks’ real loan growth was negative over the same period.

The IMF said something similar this month, pointing out that for the five largest banking groups in the region, their businesses in eastern Europe were substantially more profitable than those in the West.

That might go some way to explaining why banking stocks in emerging Europe have outperformed broader indices, in contrast to the euro zone where they have been underperforming.

But here’s the bad news – not everyone is repaying their loans. Both the IMF and Raiffeisen point to high levels of non-performing loans,  particularly in southeastern Europe. The NPL ratio in that region rose to 17.3 per cent in 2012, from 14.5 per cent in 2011, Raiffeisen says:

The high NPL ratios in Hungary and Slovenia still have a significant negative impact on the entire CE-region, overshadowing the stable or declining NPL ratios in the Czech and Slovak banking sector.

Erik Berglof, chief economist at the European Bank for Reconstruction and Development, which last week slashed its emerging Europe and North Africa growth forecasts, was also concerned. At the bank’s annual meeting this weekend in Istanbul, he said:

“We are watching some countries in southeastern Europe, Slovenia is also a part of this story and Ukraine and Moldova – there is not much reason for optimism.”

 

 

 

The civil aerospace sector performed well in 2013, according to Societe Generale data, trading at a 4 percent premium over the MSCI world index, while the defence sector has steadied, and in the medium to long term civil aerospace should be supported by strong orderbooks from emerging economies.

Research from PwC shows the global aviation industry is set to increase by 3.3 percent to 68 billion by 2022, driven by an increase in fleet size.

Last month China decided to ease a boycott of $11 billion in Airbus jet orders. A letter seen by Reuters gives a breakdown of the A330 orders, the details of which have been mostly kept secret awaiting final approval from the Chinese government.

They include 10 aircraft for Air China, 10 for Hainan Airlines, 10 for China Southern and 15 for China Eastern. The letter said first deliveries were tentatively scheduled for mid-2013.

China has already become the largest maintenance repairs and operations  market in Asia-Pacific and is expected to grow 9 to 10 percent annually, to reach $70 billion by 2015.

On Tuesday, Airbus results showed a sharp rise in first quarter core profit, with revenues rising 9 percent, though the aerospace group said it had consumed a significant quantity of cash to boost inventories for new projects.

Research from Societe Generale shows the largest order backlog for the industry comes from the Latin American share of the market, with an increase in aviation orders to 37 percent of the market in 2011 from 3 percent in 2000, a general trend that is set to grow given rising fuel prices.

Higher fuel prices means airlines will look to replace their fleet with more fuel-efficient aircraft and growing populations will bring increasing numbers of passengers. An increase in passenger traffic for the 2014 Football world cup championships in Rio de Janiero and the Olympic games in 2016 will fuel part of this.

SocGen has this:

With emerging economies now accounting for almost half of new orders, and Airbus and Boeing boasting eight-year backlogs, large jet delivery growth looks well set for the medium and long term.

Compared to last year EADS, the parent company of Airbus, Bombardier aerospace and Boeing are set to increase deliveries of commercial aircraft while revenues are set to grow at Boeing. EADS will see its orders drop for 2013 but the sector is due to see resilient earnings, research shows. Soc Gen has ‘buy’ ratings for EADS, Safran, Megitt and MTU as a result.

Research shows China accounts for 7 percent of Boeing’s sales. Outside the BRICs, demand for western aviation technology is evident. Oil-rich Kuwait is looking at plans by its state-owned airline Kuwait Airways to buy 25 new Airbus jets, a source told Reuters, a deal that could be worth up to $3 billion dollars.

Indian aerospace is also enjoying a round of investment through a series of joint ventures.

Source: PWC

For those curious about the global aviation industry’s outlook, the Paris airshow on June 18 should leave clear a slipstream.

We don’t need to dwell on Buxton’s track record (annualised return on his UK Alpha Plus fund of 13.7 percent over 10 years), but combined with Mark Lyttleton’s departure from BlackRock – his own star rather faded of late – I am drawn to ponder the funds industry’s views of, and hunger for, stellar talent.

It is attractive, and reassuring even, to believe that the people running our money are blessed with some innate skill for playing the markets, but I recently had to re-consider my own views on natural talent when talking to Matthew Syed, now a journalist and author, but previously England’s number 1 table tennis player for a decade. A competitor at two Olympic Games and winner of three Commonwealth Gold medals, Syed has some experience of being praised for his apparent natural ability.

He contends that some of our most cherished notions about natural talent are misplaced. Instead he argues persuasively that practice, opportunity and belief are far more important than genetics in determining success.
In a nutshell, Syed asserts that “when you look at the science rather than our own implicit biases, you arrive at the conclusion that champions are not born, they are made.”

Rather than going through these arguments in full, which Syed does best himself in his book ‘Bounce’, I will focus on a few aspects that have direct relevance for the funds industry and the cult of the star manager.

FEEDBACK

Exposure to the right opportunities is obviously vital for an Olympic athlete or a top fund manager to succeed, but Syed’s most consistent theme is a simple one: practice.

Not hard work for building character, or for some other honourable good, but because purposeful practice is far more influential in determining an individual’s success than a reliance on genes. “Those who believe in talent tend to lose motivation. Why work hard if it is all about having the right genes?”

Commodities guru Jim Rogers’ recent comments on his own experience are interesting here. “To the extent that I had any success, it was from homework,” he said. “I was willing and able to work harder than other people, but I was also willing and able to think differently from other people.”

Of course Syed’s emphasis on practice over talent does not mean that he believes effort alone guarantees success. The right mentor – perhaps the right investment manager – to learn from is vital. Intertwined with hard work is the often discomforting task of learning from feedback.

This has the potential to be a huge issue for star managers if the culture in their company is not conducive to giving (or receiving) constructive feedback, or to “think differently from other people,” in Rogers’ words. Not having your ideas challenged by colleagues, or believing your own billboard ads, is surely a slippery slope for a star fund manager.

As Syed puts it, “For those who are already ahead of the pack, it is vital they are pushed. If they stay within their comfort zone, they will not learn.”

The perils of lacking feedback, of not continuing to learn, can be seen in a striking example that Syed offers of research by Jeffrey Butterworth in 1960. This examined the ability of doctors to make diagnoses using heart sounds and murmurs over time. He found that while accuracy increases with experience as a person progresses from student to certified cardiologist, he also found that accuracy actually diminishes over time for doctors in general practice.

The explanation for this apparently surprising finding? GPs encounter cardiac cases relatively infrequently, and they have relatively limited feedback on which to base their judgments and diagnoses. How to improve? Well, after short, targeted practice, “their diagnostic accuracy soared,” says Syed.

This suggests a parallel with fund managers diagnosing, and dealing with, financial crises – even rarer than heart complaints, but also with devastating consequences. In turn it would be interesting to delve into the planning fund managers undertake for dealing with future crises of different shapes and sizes.

There is some evidence that fund managers have already learned to use their experience effectively. Analysing mutual funds registered for sale in the UK in preparation for this year’s Lipper Fund Awards, we compared winning funds against their peers and found that the average tenure of the winning fund managers is longer than the rest. From this initial examination the evidence was pretty consistent, suggesting that the fund management community may actually be a good example of practice in action – and of seeing experience make its mark.

BELIEF

Building success over the long term brings us to another aspect to consider, and something someone like Jim Rogers has in abundance: belief. Any individual has to be motivated enough by their profession to persevere with the hard work needed to succeed.

There are many extraordinary examples of the scale of hard work undertaken from an early age. Mozart had clocked up 3,500 hours of music practice before his sixth birthday, according to Michael Howe (‘Genius Explained’, 1999), while Geoff Colvin (‘Talent is Overrated’, 2008) estimates that Japanese ice skater Shizuka Arakawa fell over 20,000 times while practising her skating (starting at the age of five), but ultimately won an Olympic gold medal in 2006.

As Syed puts it, “When you appreciate that it has taken many thousands of baby steps by world-class performers to get to the top, their skills do not seem quite so mystical after all.”

This highlights the need for perseverance, underpinned by a real belief in what one is practising and trying to achieve. As the statistics above illustrate, the sheer volume of work involved in reaching the highest levels of performance is difficult for outsiders to comprehend.

But this also hints at a classic conundrum for the fund management industry. Mutual funds are designed as long-term investments, but investors often buy and sell them far quicker if they do not think returns have been good enough over shorter periods. “Baby steps” can be too small or too slow for many investors.

To a certain extent this simply underlines some of the pressures that asset managers have to deal with. But taking this aspect together with the others from Syed, one finds a well-rounded case for fund businesses to build structures which give opportunities to those willing to work hard, provide constructive feedback throughout the organisation, and create a company culture that really motivates people.

Before ending, the number cruncher in me cannot help but ask Syed about those who practised hard but failed. Is there a survivorship bias in the statistical evidence?

“I am glad to say that I found no evidence of this,” he says. “With deliberate and purposeful practice, we are all transformed with dramatic implications.”

Encouragement then even for those less-than-starry fund managers currently languishing at the bottom of the league tables.

((This is the third in an occasional series of interviews offering alternative insights for the fund management industry, which have also looked at betting on horses and charitable donations. ))

Well, it’s still hard to tell yet in the real economy that continues to disappont overall. But what’s certain is that monetary easing is contagious and not about to stop in the foreseeable future – whether there’s signs of a growth stabilisation or not. With the Fed, BoJ and BoE still on full throttle and the ECB cutting interest rates again last week, monetary easing is fanning out across the emerging markets too. South Korea was the latest to surprise with a rate cut on Thursday, in part to keep a lid on its won currency after Japan’s effective maxi devaluation over the past six months. But Poland too cut rates on Wednesday. And emerging markets, which slipped into the red for the year in February, have at last moved back into the black – even if still far behind year-to-date gains in developed market equities of about 16%!

Not only have we got new records on Wall St and fresh multi-year highs in Europe and Japan, there’s little sign that either this weekend’s meeting in London of G7 finance chiefs or next weekend’s G20 sherpas gathering in Moscow will want to signal a shift  in the monetary stance. If anything, they may codify the recent tilt toward easier austerity deadlines in Europe and elsewhere. But inevitably talk of unintended consequences of QE and bubbles will build again now as both equity and debt markets race ahead , even if the truth is that asset managers have been remarkably defensive so far this year in asset, sector and geographical choices …  one can only guess at what might happen if they did actually start to get aggressive! Perhaps the next pause will have to come from the Fed thinking aloud again about the longevity of its QE programme — so best watch those thought bubbles!

Next week’s big data and events:

G7 finance ministers and central bank governors meet in London Sat

EBRD meeting in Istanbul Sat

Pakistan general elections Sat

Bulgaria parliamentary elections Sun

China April Industrial output/retail sales Mon

France/Italy bond auctions Mon

Euro group meeting Mon

US April retail sales Mon

Indonesia rate decision Tues

EZ March industrial production Tues

German May ZEW sentiment Tues

ECOFIN meeting Tues

UK 5-yr gilt/Japan 30-yr JGB/Dutch DSL auctions Tues

EZ/DE/FR/IT flash Q1 GDP Weds

UK April jobless Weds

Iceland rate decision Weds

Greek PM Samaras in China Weds

Japan Q1 GDP Thurs

UK 30-yr gilt/Japan 5-yr JGB auction/German 2-yr auction Thurs

Spain’s Rajoy meets with unions on pension reforms Thurs

Draghi speech Milan Thurs

US/EZ April CPI Thurs

US April housing starts/permits, May Philly Fed index Thurs

Turkish rate decision Thurs

Turkey’s Erdogan in Washington Thurs

G20 sherpas meeting in St Petersburg Sat/Sun

Most major advertisers already have a foothold in these BRIC economies, where the advertising market is projected to grow by an average 10.7 percent  a year over the next three years — more than three times the growth rate in  the developed world.  Over the next 15 years,  big emerging markets will add $200 billion to the global ad spend, S&P Capital IQ reckons.

Hopes, unsurprisingly, are pinned on the soccer World Cup in 2014 and the 2016 Olympics, both hosted by Brazil. Russia hosts the 2014 Winter Games in Sochi and Football World cup in 2018 and both these events are expected to boost ad spending. The behemoths of the ad world have prepared for this, says Alex Wisch, an analyst at S&P Capital IQ:

    The global agencies have already developed a solid foundation in the BRICs, so the heavy lifting on the investment ramp is largely behind them.

(Graphic under creative commons)

Accordingly, S&P Capital IQ has a ‘buy’ recommendation on advertising agencies Publicis, Interpublic and Omnicon while advising a “hold” on WPP.

Emerging markets currently account for a small proportion of the global ad market which is estimated to be worth more than $500 billion. Despite faster growth that will remain the case, S&P Capital IQ says, noting that in absolute spending terms, North America will contribute as much to global advertising expenditure as China, Brazil and Russia combined over the next three years.

While Europe looks set for more disappointment, the report predicts faster momentum in North American markets as economic recovery gathers steam. One reason is digital advertising — internet advertising, digital marketing and data services  –which is better established in the United States.

The outlook is  ‘cautiously optimistic’ for global advertising agencies, driven by further expansion in higher growth markets, the report concludes.

Watch that ad space…

So where does that all leave us? A third of the way through 2013 and it’s been a good year so far for nearly all bulls – both western equity bulls and increasingly bond bulls too! Not only have developed world equities clocked up some 13 percent year-to-date (the S&P500 set yet another record high this week while Europe’s bluechips recorded a staggering 12^th consecutive monthly gain in April) , but virtually all bond markets from junk bonds to Treasuries, euro peripherals to emerging markets are now back in the black for the year as a whole. For the most eyebrow-raising evidence, look no further than last week’s debut sovereign bond from Rwanda at less than 7 percent for 10 years or even newly-junked Slovenia’s ability this week to plough ahead with a syndicated bond sale reported to already be in the region of four times oversubscribed. For many people, that parallel rise in equity and bonds smells of a bubble somewhere. But before you cry “QEEEEE!” , take a look at commodities — the bulls there have been taken a bath all year as data on final global demand hits yet another ‘soft patch’ over the past couple of months.

So is this just an idiosyncratic random walk of asset markets (itself no bad thing after years of stress-riven hyper correlation) or can we explain all three asset directions together? One way to think of it is in terms of global inflation. If QE-related inflation fears have been grossly exaggerated then pressure to remove monetary stimulus or wanes again and there may even be arguments – certainly in Europe – for more. This would intuitively explain the renewed dash for bonds and fixed income in general even in the face of the still-plausible, if long term, “Great Rotation” idea. You could argue the monetary free-for-all is buoying equities regardless of demand concerns. But why wouldn’t commodities gain on that basis too?

The answer likely lies in the desperate demand among big institutional investors for income in a low-growth, QE-buoyed world. The paltry income left in ‘safe’ bond markets becomes less unappealing if the inflation horizon is lower than we thought and from there the push for more yield fuels all bond markets. Similarly this year’s equities rally has been remarkable because it’s been led by income-like, blue chip defensive stocks with decent dividends that ape bond returns – and not by growth stocks or even emerging markets, which still remain in the red.

And if income is the only game in town and there’s no inflation scare, then the last place you want to be is income-less commodities.

So, what’s up next week? Tomorrow’s US payrolls report set the tone. But next week throws up a G7 meeting, heavy UK/European earnings sked, Chinese trade and inflation, BoE meeting and US/German bond auctions.

GLOBAL DATA/EVENTS TO WATCH

Malaysia general elections Sun

Europe Q1 earnings Mon: AXA, BCP, Natixis

EZ April services PMIs/March retail sales Mon

French debt auction Mon

Australia rate decision Tues

Europe Q1 earnings Tues:  HSBC, Lafarge, SocGen, Pirelli, , Commerzbank, Adecco, Banca Generali, Carlsberg, Credit Agricole,

Swiss Q2 confidence, April jobless Tues

French March trade and industrial output Tues

US March consumer credit Tues

US 3-yr debt auction Tues

China April trade data Weds

Europe Q1 earnings Weds: Deutsche Telekom, CRH, Aegon, ING, Dexia, Henkel, J Sainsbury, Next, Standard Chartered,

German 5-yr bund auction Weds

German March industry output Weds

Madagascar Presidential Elections Weds

Norway rate decision Weds

US 10-yr Treasury auction Weds

China April inflation Thurs

SKorea/Malaysia/Egypt rate decisions Thurs

Europe Q1 earnings Thurs:  Barratt, Beazley, WM Morrison, Old Mutual, Repsol, Tullett Prebon

UK March industry and manufacturing Thurs

Bank of England rate decision Thurs

US 3-yr Treasury auction Thurs

Europe Q1 earnings Fri: Unicredit, ArcelorMittal, TUI

German/UK March trade, Italy March industry Fri

G7 finance ministers and central bank governors meet in London Fri/Sat

EBRD meeting in Istanbul Fri/Sat

Pakistan general elections Sat

Bulgaria parliamentary elections Sun

As we said here and here, Japanese cash outflows to world markets have so far been limited to a trickle, almost all from retail mom-and-pop investors who like higher yields and are estimated to have 1500 trillion yen ($15.40 trillion) in savings. As for Japan’s huge institutional investors — the $730 billion mutual fund industry and $3.4 trillion life insurance sectors — they are sitting tight.

If some are to be believed, the hype over outflows is misguided. Morgan Stanley for one reckons Japanese insurers’ foreign bond buying may rise by just 2-3 percent in the next two years, amounting to $60-100 billion. Pension funds are even less likely to re-balance their portfolios given large cash flow needs, the bank said.

But a Reuters survey last week revealed several insurance companies are indeed considering boosting unhedged foreign bond holdings.  Insurers currently hold almost half their assets in Japanese government bonds and risk being crowded out of the JGB market as the central bank ramps up purchases.  A recent survey by Barclays also showed Japanese investors keen on overseas debt.

Barclays analyst Bill Diviney offers the following explanation as to why institutional investors haven’t ventured out so far:

From the life insurer investment plans released last week the basic takeaway was that in terms of current levels in currency and given the rally in emerging and developed bonds of late they seem to be uncomfortable with the current price levels and the sense I get is that they are waiting fro a dip in the market. So the markets have risen in anticipation of Japanese flows but the investors themselves want to wait until there is more value and better buying levels.

He adds:

Judging from what they are saying they will be shifting allocations away from JGBs. That will have implications for fixed income market. But… their main interest is in developed markets, they are cautious and not really interested in chasing high yields. 

A survey by Barclays  (see graphic above) revealed that U.S. and German debt were Japanese investors’ preferred choices while only 20 percent of respondents thought emerging market bonds would see an increase in Japanese investment. Unsurprising, given how risk-averse these investors are. (Italy and Spain get even fewer votes) But Diviney reckons  emerging bonds will benefit from Japanese  outflows indirectly, via so-called displacement flows — if Japanese cash drives down yields on Treasuries and Bunds, some other investors might be pushed to seek returns in emerging markets, he says.

Smith, who is head of emerging equity strategy at Deutsche Bank, sees no reason to change his call. Reckoning that the cyclical heyday of emerging markets is past, he is advising clients to hold on to developed and U.S. equities at the expense of emerging markets. The reason? China, pivotal for the rest of the EM world for commodities, trade.

Smith writes:

We are maintaining our existing underweight recommendations for GEM versus DM/US and current country weightings within GEM because the ongoing structural deterioration in the sustainable growth rate of the Chinese economy will continue to be the dominant narrative for the GEM equity asset class, in our view. Since the start of the year it has been increasingly evident at the micro level that the massive increase in total corporate financing has not as yet fed through into anything resembling a commensurate pickup in final demand.

Recent data from China would appear to bear that out. Economic growth and industrial data have both disappointed while Fitch has downgraded the country’s local currency rating, warning of risks to the economy from so-called shadow banking. And corporate results have not been reassuring — over 70 percent of companies, whether Hong Kong- or mainland-listed, undershot earnings forecasts for 2012,  according to Thomson Reuters Starmine data.

Smith again:

From a more bottom-up perspective, the ongoing deterioration in the underlying return on invested capital has now reached a point which threatens the viability of the entire economy.

So how China plays out will determine performance of the rest of the asset class. If China slows down gradually, emerging equities would underperform, led by commodity producers Russia and Brazil, while commodity importers such as India and  Turkey would gain. A more dramatic outcome in China would swiftly hit the most expensive markets such as Thailand and Malaysia, and also affect countries with current account deficits.

Within emerging markets, Smith is shunning Brazil, Russia, China and Korea but he has tactical overweights in Poland, Taiwan, Mexico, Turkey and is neutral/overweight in India — trades that would broadly benefit from a Chinese slowdown.