Thursday, May 18, 2006

Short view By Richard Beales - Financial Times

THE SHORT VIEW MARKET COMMENT
By Richard Beales in New York
Published: May 18 2006 03:00 | Last updated: May 18 2006 03:00. Copyright by The Financial Times

"What the wise man does in the beginning, the fool does in the end," Warren Buffett told Berkshire Hathaway investors earlier this month.

Emerging market equity investors might do well to heed his words, which referred to the run-up in commodity prices. The recent stumble in both markets could be the beginning of the end - or just a blip. But jitters remain, amid uncertainty over the US economy.

Michael Hartnett and colleagues at Merrill Lynch wonder whether the "humiliation" that once made emerging market stocks good value has been replaced by "hubris". They conclude that, despite the caution warranted by bubble-like fund inflows, the greed, leverage and egregious valuations of a true bubble are still not obvious in most markets.

Equity investors should, however, take note of two of Merrill's rules: stay long until the Federal Reserve stops raising US interest rates and stay long until the commodity cycle reverses. Both events could be close - or already here.

The debt story is different. Emerging market sovereign spreads over Treasuries widened from 1.74 percentage points at the beginning of this month to 1.95 points on Monday. They have since narrowed slightly.

Proponents say debt is far from the contagion-ridden, volatile market it was five years ago. Just under half the leading emerging market debt index is now rated investment grade. Most, though not all, of the economies run surpluses. Many of their currencies float freely.

Demand from big US and European pension funds for fixed-income assets is also rising and emerging market sovereign debt is increasingly becoming a mainstream asset class. That includes local currency paper - a consistently less volatile investment than

US Treasuries for the past seven years, says Jerome Booth at Ashmore Investment Management.

All that should make emerging market debt more resistant to swings in other markets. It is not, however, immune. As Jeff Grills of JPMorgan Asset Management notes: "A big enough US problem could still become an emerging market problem."

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