Emerging Markets: Highway to the Danger Zone!

Bloomberg wrote a pretty fair and accurate article on the over-valuation of emerging markets. I didn’t trim this article as I found the entire piece to be interesting. Note the references to IMF and also World Bank growth forecasts. I’m not sure the game that’s being played here, but now when I see a piece that largely tells the over-valued truth I get suspicious as to the motive. Is it time? Are the central bankers positioned correctly for this article to play?

I know, but you must have a skeptical mind for these markets, things are NOT what they appear on the surface.

Emerging Markets Priciest Since 2007 When Shares Fell

By Adria Cimino and Michael Patterson

July 13 (Bloomberg) — The last time stocks in developing countries got this expensive was in October 2007, just before the MSCI Emerging Markets Index began a 12-month tumble that erased half its value.

The MSCI gauge trades at 15.4 times reported earnings, compared with 14 for the Standard & Poor’s 500 Index, according to weekly data compiled by Bloomberg. When developing nations last commanded a premium, the 22-country benchmark sank 54 percent in the next year.

Groupama Asset Management, Palatine Asset Management and Standard Life Investments say the disparity means investors are paying too much for shares from China to India to Brazil at a time when the global economy is contracting. MSCI’s emerging- market gauge is valued at 1.7 times its companies’ net assets after a 34 percent surge last quarter, the highest on record compared with the MSCI World Index of 23 advanced economies, which trades for 1.5 times, data compiled by Bloomberg show.
……
When emerging-market valuations climbed above the U.S. in 1999 and 2000, it foreshadowed the end of a seven-year global rally. The MSCI developing-nation index sank 37 percent in the 12 months after March 2000, compared with a 23 percent slide in the S&P 500.
……
Shares in developing nations are the most vulnerable to further declines because prices “have run too far ahead” of a recovery in profits, according to Standard Life’s Jason Hepner.

Companies in the MSCI emerging-markets index that reported results since the end of the first quarter posted an average earnings drop of 92 percent, trailing analysts’ estimates by 14 percent, according to Bloomberg data. That compares with a 46 percent profit slide for Europe’s Dow Jones Stoxx 600 Index and a 31 percent fall for the S&P 500, Bloomberg data show.
……
“A lot of risk assets are ahead of themselves,” said Doll, vice chairman and chief investment officer of global equities at New York-based BlackRock, which had $1.3 trillion under management as of March 31. “Almost always, what goes up the most, pulls back the most.”

Read the whole thing »

Indeed! I agree that a lot of risk assets are ahead of themselves, but agreeing with a public statement made by someone running BlackRock makes me nervous.

I do think that it’s interesting that some of the developing nations banks are in relatively better condition. Those parts of the world that didn’t participate in the securitization/ “derivatization” of everything above ground have been and will probably continue to be relatively better off.

Still, they are dependent upon demand from the rest of the world, so expecting fundamental REAL growth is probably not the brightest call at this juncture – doesn’t mean that speculative “hot” money can’t run these markets higher.

Below is the Point & Figure chart for the Emerging Market Index. Note the very bullish target of 63! I highly doubt this index will reach that height with this fundamental backdrop. However, betting against them now might be a little dangerous, especially with BlackRock making comments like that!

Another thing that gives me pause about this chart is that I see the “dragon” pattern here. I won’t try to draw it, but imagine the tail on the left, two feet, a long neck and a head… when the head is above the “back” it is a bullish formation as it is here. So, if you go back to the chart at the top of this article, you will see that formation there too. Note also that it retraced half of its enormous decline and then fell back to the 38.2% retrace line where it is finding support now. To me it looks like it may fall back to the 23.6 which places prices at the top of the “dragon’s back.”

Overall I think emerging markets are over valued. But I also think playing these markets in either direction is playing in the danger zone.

Graph: StockCharts

• Become A Funded Futures Trader