* Emerging debt starting to look expensive after strong year
* Emerging equities showing some pricier sectors eg consumer
By Carolyn Cohn
LONDON, Nov 15 The looming U.S. fiscal cliff of
tax rises and spending cuts combined with renewed euro zone
tension over Greece are threatening demand for riskier emerging
market assets, just when some are getting expensive.
It is all making the asset class vulnerable to a pullback.
Once high-yielding bonds are offering less than they were
and although emerging equities have performed less well than
fixed income, some sectors within them are looking pricey.
Emerging sovereign debt , for example, has
enjoyed returns of 16 percent this year, outstripping most of
the developed world. As a result, yields have fallen
"The market has rallied a lot, it's much less compelling to
invest now, for a 4 percent yield," said Sergei Strigo, head of
emerging debt management at Amundi.
"Since the beginning of the year, (yield) spreads have
tightened by at least 180 basis points in places like Romania."
Data from Boston-based fund tracker EPFR continues to show
net inflows into emerging bond funds, as has been the case for
every month this year. Emerging equities have also enjoyed
consistent inflows for the past few months.
But market participants are starting to get more cautious.
Morgan Stanley analysts, for example, cut their
recommendation on emerging market assets to "hold" from
"accumulate" ahead of the U.S. election last week, for the first
time since June, and maintained that position this week.
For Lipper GRAPHIC on emerging bond flows, see link.reuters.com/hyk93t
For GRAPHIC on global government bond returns this year, see link.reuters.com/ren26s
RISE AND FALL?
Investors have flocked to emerging market debt this year,
attracted by lower debt levels in many of the sector's
economies, a broad trend for rising ratings across the asset
class and ultra-low rates in developed markets.
Emerging hard currency bond issuance has hit record levels,
and analysts have revised up their borrowing forecasts for the
year to well over $300 billion.
European Central Bank President Mario Draghi's pledge in
July to do whatever it takes to preserve the euro, followed by
the promise of the ECB's bond-buying programme, also swelled
appetite for riskier emerging markets.
But the tightening in emerging sovereign debt spreads,
particularly since the summer, has triggered alarm bells.
Emerging sovereign debt spreads have
narrowed around 150 basis points this year to 270-290 bps over
That's still well above record low levels of 150 bps hit in
mid-2007, before the global financial crisis. But U.S.
Treasuries offered higher yields then, giving average total
yield for emerging market debt of more than 6 percent, compared
with little more than 4 percent now.
Fair value for spreads is at levels tighter by only around
another 20 basis point, Morgan Stanley analysts say, due to the
renewed pessimism about the developed world.
"U.S. and European concerns are likely to hold back
significant risk-taking as we head into year-end," they wrote in
a client note.
Emerging stocks have risen a more modest 8 percent
this year, keeping pace with developed world bourses but also
masking some huge gains in frontier markets, such as the 35
percent surge in African stocks.
Some equities sectors, though, are also starting to look
pricey. Investors are well aware of the theme of the growing
middle class in emerging markets, particularly in some of the
newer markets, and this has made consumer stocks a favourite --
maybe too much of a favourite.
"Over the last two years, a lot of investors have been
focusing on consumer staples which has taken the sector up to
quite aggressive valuations and given very limited scope," said
Knut Harald Nilsson, portfolio manager at Skagen.
Forward price/earnings (PE) ratios stand at around 21 for
the sector, compared with a 12-year average of about 15,
according to Datastream.
This makes it more appealing to buy consumer stocks listed
in developed markets but with emerging market exposure, Nilsson
So if emerging sovereign debt isn't great and neither are
some emerging equities, where else is there to go?
Investors have already rotated this year into emerging
corporate or frontier debt, and even into peripheral euro zone
There could be more of that to come.
(Additional reporting by Joel Dimmock, Vincent Flasseur and
Sujata Rao. Editing by Jeremy Gaunt.)