Exotic Emerging Bubble

Emerging market hedge funds who are investing in Exotic stocks, such as Brazil, Russia, India and China, have seen some stormy weather in the past two months. Almost all the emerging markets have since turned around, but the selloff looked like a sign that emerging stocks may be overvalued according to Birinyi Associates, a stock research firm.

In the selloff that started in May and lasted until Wednesday, when many markets began to recover, emerging market losses were steep, the Morgan Stanley Capital International Emerging Markets Index dropping over 10 percent.

Some hedge funds investing in emerging markets lost over 4 percent in May/June, as stock markets from India to Chile slumped. Hedge funds focusing on Eastern Europe and the former Soviet Union suffered the most, dropping more than 6 percent, according to Hedge Fund Research. Asia-focused funds shed 3.63 percent. The Latin America index fell 1.56 percent. In the weeks between May 9 and June 13, stocks in Brazil fell 29.59 percent. Indian stocks fell 32.44 percent, tumbling from their all-time high, and stocks in Mexico dropped 24.72 percent, according to Birinyi. In one month, foreign investors pulled $2.7 billion out of Indian stocks alone.

Emerging markets in general are much more resilient today than they were a decade ago, but fears about higher worldwide interest rates and the next move by the Federal Reserve lopped $6.26 trillion in value off all markets, including the U.S., according to an analysis by Birinyi Associates.

Much of the inflow of funds in recent years was driven by a search for yield at a time of ultra-low interest rates in the developed world. As interest rates rise in the US, eurozone and Japan, this trade has come under pressure and investors have poured so much money into emerging markets, that some on Wall Street are comparing it to the tech-stock bubble of the 1990s.

The recent and sudden input of new money, especially from hedge funds, many of which now are among the largest shareholders of companies in Turkey, Argentina and Mexico, may not have had the experience to withstand the unstability of these markets. Investors poured almost $340 billion into hedge funds globally during the past five years, increasing the industry’s assets to $1.3 trillion, according to Hedge Fund Research.