Saturday, January 06, 2007

Emerging Market Fund Flows Are Record


First off, I am wondering if anyone has heard ot the rumbling out of China re some imminent announcement? Is this the accouncement of currency float or rumors? If so, it isn't for the obvious reasons of international good will. As I have written of on here, China's monetary growth is even higher than pre-1929 and Bloomberg just announced the government had finally been able to drop it to 17% growth. That is an amazing and frightening statistic. Because the Chinese banking system is in shambles, officials are unable to raise rates. Doing so may cause a wave of bankruptcies, calls on noperforming loans and increased liquidity flows into the country. So, officials have been attempting economic control by raising reserve requirements. China's economy might be in a melt up which would be consistent with the fever in stocks recently. The government officials may not have a handle on the economy. One of the few remaining options might be to float their currency. In part, this would reduce the flow speculative money banking (no pun intended) on a currency revaluation. We might already be in a global mess. Now, all of this is heresy at this point but let's watch from afar and see if rumor turns into reality.

Now, back to other reasons for this post. I pulled a few charts early this past week after my post where I referred to the large December moves in Chinese and Russion equities. I should state I am bullish on some emerging markets over the long term. Of course, that is after their stock markets fall off of a cliff and I have time to digest the implications. I especially like India if they continue their reform movements. There is some reason to doubt they will. Or, at least that it will be a nonlinear reform effort. But, as I've mentioned before, India has tremendous synergies with democratic and western cultures. But, then I'm uber bullish on the American stock market long term as well. I'm just not bullish today.

Emerging market equity and bond fund flows set records in 2006. The largest beneficiary? China. It appears Americans and Europeans have developed a taste for communist economics since most international flows are from both markets. Let's wonder out loud. Have we ever had western investors invest in a communist economy? Do investors become honorary members of the Chinese communist party if investing in their B shares or H shares? Do they really understand the risks associated with a centrally planned economy? Hardly.

Re my post a week ago, China and Russia have had nice decade long runs in the last few months. I can't pull a decent chart on the Shanghai or Russian indices so I am using an ETF and mutual fund posted above. These charts are a few days old as I typed this up a few days ago. Above are the Templeton Russian Fund which I believe I have posted before and the FXI China ETF. Does anyone know what a parabola is?

What conclusion do I draw from this flow of funds statistic? Only one. Americans and Europeans are willing to take on unprecedented levels of risk. With credit spreads nearly nonexistent and emerging market indices doing so well over the last few years, it appears investors have been lulled into a bout of stupidity about future returns. Here we go again. Driving through the rear view mirror and listening to the chant of diworsification from Wall Street. Does anyone even know why an investor is supposed to diversify? If I eat red M&Ms, blue M&Ms, yellow M&Ms and green M&Ms, I'm still just eating M&Ms. Diversification might be acceptable if the assets are noncorrelated either historically or within a cycle with compelling analysis. But, global investments and asset classes are all highly correlated this cycle. As I said before, that should give one reason to pause.

Russia's return over the last four years has been ok. For a quarter century of investing returns that is. What does that chart show? About 10% per annum return for twenty five years achieved in a few years. So what is Russia doing different today from a handful of years ago when their currency went kaput and they quit paying their bills? Oh, I forgot. They are benefiting from a weak dollar and overpriced traditional investments in the western world. So, Wall Street drove commodities through the roof and Russia benefited. Now they are an economic miracle of emerging markets. Huh? Smart money was allocating capital to Russia in 2000 and 2001. Dumb money or fast money or both was buying near the peak. See those wide price swings in 2006? Those are volatility. 50% moves in less than two months. How fun is that? Wouldn't it be fun if the Dow went up and down from 6,000 to 12,000 in a month or so? So what is volatility synonymous with? Indecision? Market Tops? Hello! Can you hear me now?

Anyone who bought Russian equities in 2000 has alot of moxie. I'd like to shake your hand. Right after you buy me a yacht because you made a killing of a life time. Anyone who is buying Russian equities today? Well, I might be buying you lunch at the poor house.

posted by TimingLogic at 2:19 PM