ANALYSIS-Emerging stocks rebound seems more than bear rally

Published: 11 May 2009 05:37:14 PST

* Fund flows returning as global risk appetite improves

* Helped by improved outlook for China

LONDON, May 11 - Recent gains in emerging market equities show signs of being more than a bear market rally as many investors reckon fund flows are returning to an asset class hit more than most over the turbulent past year.

A sharp rebound in global risk appetite, improved prospects for China, signs the world economy is stabilising, and a huge financial boost for the International Monetary Fund have driven emerging markets, which have outperformed developed peers.

"Emerging markets are the only part of the world where there is relatively good news," said Jeff Chowdhry, who runs $1.5 billion in global emerging equities at fund management firm F&C.

"There is some growth, whereas there is no growth in the developed markets. For investors, it's the only game in town."

MSCI's emerging equities index <.MSCIEF> is up 28 percent in 2009, compared with a 6 percent rise in its global equivalent <.MIWD00000PUS> and reversing much of 2008's underperformance.

What is more, emerging equity funds posted their best week of the year in the week ended May 6, consultancy EPFR Global said, taking $3.6 billion in a ninth straight week of inflows.

Also, State Street Global Markets data showed the most risk-seeking investment regime since May 2008, with institutions buying emerging markets "aggressively".

For both emerging markets and developed markets, the fortunes of the world's largest emerging market, China, are key.

Chinese demand needs to keep growing at a strong rate to boost economies in other export-producing emerging markets.

China introduced a $600 billion package to stimulate its economy last November. The economy is expected to grow 7-8 percent in 2009 and 2010, a central bank adviser said last week.

On Monday, deputy central bank governor Su Ning said the stimulus was working better than expected, while crude imports data showed a spike in demand. [ID:nSP426267]

"It's not that China is on an upward trajectory, it's a sense of relief that it will sustain 6.5-8 percent growth. That's a big driver," Philip Lawlor, chief portfolio strategist at Nomura, said:

Some analysts pinpoint the start of the emerging equity rise to mid-March when G20 finance ministers proposed a large increase in the IMF's capital to boost emerging economies.

G20 leaders agreed last month on a bigger-than-expected $1.1 trillion package for the IMF. [ID:nL1230573]

A new IMF flexible credit line for well-managed emerging economies, already adopted by Mexico and Poland, has also taken the stigma out of resorting to the IMF.

The positive signals, along with a few signs of recovery in U.S. economic data and the global banking sector, have spurred a return of risk appetite, a must for emerging equities.

"The rally can continue for a little while yet. The reason for that is that a lot of people missed out on the rally or have been too defensively positioned," said Chowdhry.

RUSSIA, CHINA

Among emerging economies, Russia was seen benefiting from the price of oil, which has climbed 75 percent in the past two months to $57 a barrel, albeit a third of its July 2008 peak.

Michael Hartnett, co-head of international investment strategy at Bank of America Securities-Merrill Lynch in New York, said the bank was "stubbornly long" in Russia.

Hartnett said in a client note that for Russia, the world's second-largest oil exporter, there was "huge upside if oil breaks $60 per barrel", and that investors were marginally underweight and valuations very cheap.

Negatives on Russia were its political backdrop, economy and worries over corporate debt refinancing, he said.

Hartnett also liked China <.SSEC>, but F&C's Chowdhry said the market there may be set to consolidate, after rising 42 percent this year.

Chowdhry also said investors should start to think about two bugbears of the global financial crisis -- financial institutions and eastern Europe, which has suffered from taking too much advantage of western banks' lending spree.

"We have seen a return of risk appetite in the developed markets, the financial market sector is the obvious place to go. Emerging market banks had their crisis 10 years ago, lending has been much more prudent," he said.

"At the start of the year we had nothing in eastern Europe apart from Russia, but we have been adding. A lot of bad news is in the price. It's not appropriate to go overweight in the region, but things are not as bad as they were."

However, some analysts expressed a note of caution.

Jonathan Garner, emerging equities strategist at Morgan Stanley, said while the emerging equities index was likely to hit 810 by the end of this year, around 12 percent above current levels, it was currently showing short-term 'sell' signals.

Lawlor at Nomura also doubted whether the rally had much further to run. "We could start going through summer doldrums, through sideways trading. We are kidding ourselves if we think we have the liquidity for a strong bull market. We are in a 4-5 year period where we are trending up at a pedestrian rate."