Global Investor: Waiting for That Big 'Pop'; Is the Emerging-Markets Boom Now a Bubble, and Is It Ready to Burst? for an Important Clue, Take the Temperature of the U.S. Economy
Sharma, Ruchir, Newsweek International
Byline: Ruchir Sharma (Sharma is co-head of global emerging markets at Morgan Stanley Investment Management.)
There is only a fine line between euphoria and acrophobia. And most emerging markets are currently torn between the two sensations. Emerging-market stocks have been the asset class of choice this decade, rising by nearly 200 percent over the past three years. However, the rally in many of these markets has been fueled largely by ebullient foreign investors, who have poured in more than $150 billion during this period. Even today, domestic investors think this "levitation act" just can't last.
Both sides make equally strong arguments on whether the rally is peaking. Valuations in most emerging markets are at the higher end of their recent trading range but, in general, well below levels that prevailed in 1994 and 2000--the major turning points in the last two emerging-market bull runs. Global investors point to the dramatic improvement in emerging markets' macroeconomic profile--including trade surpluses and low inflation--while local investors in several large countries cite the fading reform momentum as part of their long list of negatives.
When one analyzes major trends, it's often helpful to rely on historical precedents and ignore the daily trench warfare. Bank Credit Analyst, an independent research firm, argues that investors tend to get caught up in one theme each decade, and that theme typically turns into a mania or bubble. But contrary to popular belief, financial-market bubbles aren't made of thin air.
They are based on genuine changes that present new profit opportunities and lead to a boom. Investors are at first slow to recognize the new phenomenon but subsequently rush to participate in it, and eventually go too far. History is littered with episodes of bubbles, from the financial-engineering-driven South Sea bubble in the 18th century to the railroad mania in the 19th century, which was based on the greatest technological invention of that period. Then there was the bubble of the 1920s, formed out of an extended period of prosperity in the United States during the early part of the 20th century.
More recently, in the late 1960s, it was the emergence of multinationals that caught the imagination of equity investors. This group of U.S. companies--called the "nifty 50"--had earnings so strong that investors believed their incomes were shockproof. Commodities, such as gold and oil, were the main theme of the 1970s bubble story. …