Such echo rallies are never as big as the original one and we will see it fading away, Ruchir Sharma, 35, who oversees $25 billion in emerging-market stocks at Morgan Stanley, said in an interview in Mumbai. The rally will end as the effects of the stimulus begin to fade and the credit bubble caused by easy money disappears.
The MSCI Emerging Market Index, which tracks shares in developing markets, has surged 59% this year, is set for its biggest annual advance since 1993, as governments poured in $2 trillion and central banks cut interest rates to near zero to kick-start their economies. Last year, the measure dropped 54%, its worst run.
The emerging-market index fell 1.3% to 904.64 as of 5.10 pm in Mumbai, a four-week low, after the Standard & Poors 500 Index lost 2% to 1,042.63 on Thursday, the steepest drop since October 1. Sharma, the New York-based head of emerging markets, said he expects the S&P 500 to trade in a long-term range of 800-1,200 in the next couple of years.
Markets globally dropped last year following the biggest financial crisis since the 1930s as the bankruptcy of Lehman Brothers Holdings Inc and writedowns from subprime debt caused a seizure in lending.
Only 31% of respondents to a poll of investors and analysts in the US, Europe and Asia see investment opportunities, down from 35% in the previous survey in July. Almost 40% in the latest quarterly survey say they are still hunkering down. US investors are even more cautious, with more than 50% saying they are in a defensive crouch.
Sharma predicted in May 2006 that emerging markets will post further gains. The index for developing nations has risen 20% since then, compared with a 16% drop in the MSCI World Index.
The commodity-producing nations will be the hardest hit when the current rally ends, Sharma said. The Latin American markets of Brazil and Chile are the most expensive, he said, and Morgan Stanley is also underweight on Taiwan, Malaysia, Israel and Russia. Commodity prices are rising even as economic fundamentals are deteriorating, he added, a sign that the rally may be fizzling.
Commodities are at the centre of this echo bubble, he said, adding that they are in substantially overvalued territory, way above fundamentals.
Inventories of oil, copper and aluminium have risen over the past few months even though demand hasnt picked up, Sharma said, adding that the price of oil is inversely correlated to the US dollar. Increasing buying of commodities as a hedge against the decline in the US dollar has resulted in the commodity rally, he said.
The greatest degree of irrationality is in commodities, Sharma said. Morgan Stanley owns a lower percentage of commodity stocks, including metals, materials, energy and industrials, compared with the benchmark index. It holds a higher percentage of financial and consumer stocks including automobiles, retailers and beer companies.
Some brokerages are predicting further gains in equities. The emerging markets benchmark stock index may retest its life high by next year, helped by economic growth and gains in credit markets, according to JPMorgan Chase & Co.
The optimism is shared by Mark Mobius, who oversees about $25 billion as executive chairman of Templeton Asset Management Ltd. The investor said this month he expects developing nations shares to surpass previous records, predicting a continued rally with corrections along the way.
Emerging markets make up all ten of the worlds best-performing markets. Russias dollar-denominated RTS Index has been the worlds best performer this year after climbing 112%.
Morgan Stanley is overweight on India, Indonesia, Poland, the Czech Republic, Turkey and Thailand, as its betting on economies that are driven by domestic demand. India, Indonesia and the Czech Republic are among the few countries that will end the year with earnings per share growth at all time highs, while countries like Russia and Taiwan will see corporate profits climbing back to their peaks in 2012, Sharma said.
Some markets may be hurt by the diversion of government stimulus away from the economy and into stocks and other investments. Central banks globally were hoping the funds would result in an increase in credit growth, driving the economy. That remains weak in most countries, Sharma said. Liquidity has found its way to the wrong assets, he said. You can take a horse to the water, but cant force it to drink.