The massive global market rally rests on a knife-edge, as
signs of sluggish consumer demand in rich countries threaten to
puncture sky-high valuations in bond and equity markets,
analysts warned this week.
The market rally has, in some cases, gone beyond what
would be warranted on the basis of the outlook for
fundamentals, said Mohamed El Erian, co-chief executive
at Pimco, in an interview with Emerging Markets.
Fears of a sharp correction in risky markets are growing
after fresh signs that weak consumption will drag down the
economic recovery in the US.
Emerging market stocks this week followed the sell-off in
Western markets. Spreads on hard currency sovereign bonds this
week widened by 15bps to 341bp, and key currencies also
On Thursday, US manufacturing was dealt a major blow as the
Chicago purchasing managers index (PMI) posted a decline of 3.9
points to 46.1 in September.
This was below the consensus expectation of 52.0 and
demonstrates that as US producers reinvested, consumer demand
stalled last month.
As Emerging Markets was going to press, all eyes
were on the US non-farm payrolls data expected late on Friday.
Market jitters are based on fears over the fragility of the US
economic recovery, as consumption the key driver for US
growth remains feeble.
But despite this softening in market tone, emerging markets
have largely weathered the US equity sell-off, Paul Biszko,
senior emerging markets analyst at RBC Capital Markets, said.
Markets have priced in, and continue to price in, an
optimistic growth scenario, despite this worrying
After massive rebounds in the second quarter of the year,
emerging stock markets have maintained their ascent but at a
slower pace. The MSCI Emerging Markets Index gained 20% in the
third quarter of the year, compared with a 34% jump in the
second period. Hard currency sovereign bonds are now not far
from levels seen just before the September 2008 crash of Lehman
The combination of zero short-term interest rates,
which push investors into higher risk assets, and massive
liquidity injections has caused markets to price in a
V-like economic recovery for 2010, El Erian
In many cases global stock valuations are not based on
sustainable drivers based on private
components of aggregate demand but temporary liquidity
stimulus policies from G7 central banks and a bounce in
restocking of inventories, El Erian argued.
Emerging market equities, on a price-to-earnings basis, now
trade at the same valuation as developed stocks or at a slight
discount on a forward price-to-earnings basis. Biszko argued
that emerging market stocks and bonds can continue to trade
tight, while lax monetary policies remain, as no-one is
thinking of withdrawal of liquidity stimuli now.
But the bigger the rise, the greater the fall. Barry
Eichengreen, professor of economics at UC Berkeley, warned that
the history of emerging markets with their traditional
lack of transparency and poor governance issues
suggest investors should beware that profitability of listed
firms and corporate issuers is far from guaranteed, despite the
more positive economic fundamentals.