April 22, 2014 5:44 am JST

Pitfalls lie ahead for emerging-market investors

MAKOTO KAJIWARA, Nikkei senior staff writer

TOKYO -- Some investors are returning to sluggish emerging-market stocks, but this may prove dangerous without real improvement in the economic climate.

     The Nikkei Stock Average retreated slightly Monday, but the mood is not bad after last week's performance, including a week-on-week increase of 4%, the highest among major global market indexes.

     Worries mounted on April 14 as the Nikkei average reached a year-to-date low. It rebounded 420 points on April 16, when China's January-March gross domestic product came in above market expectations.

     Although concerns over a slowdown continue to smolder, signs are pointing upward for consumer spending. Retail sales grew more than 12% on the year in March, up from the January and February figures.

     This was reflected in Japanese stocks. Cosmetics maker Shiseido's share price, which reflects Chinese consumer spending, continues to beat the Nikkei average, rising 9% so far this year.

     Receding worries over the Chinese economy are likely to spur investors to reconsider their positions on emerging markets.

     Only $1.8 billion moved out of emerging-market exchange-traded funds worldwide in March, according to U.S. investment company BlackRock -- significantly less than the $8.7 billion outflow in January, when the Argentine peso plunged and emerging markets were caught up in turmoil.

     Money has flowed into some markets this month as well. Brazilian stocks have recovered 16% from their March low, and India's benchmark index reached a record high.

     Emerging economies are easily swayed by China. JP Morgan calculated the overall effect of slowdowns in industrialized countries on these markets. If Japan's gross domestic product drops by 1 point, emerging-market GDPs decline only 0.2 point. But a 1-point slide in China drags emerging-market GDPs down 0.7 point or more.

     This lends weight to the idea that receding China worries mean less worries over emerging markets, leading to more buying of stocks there.

     But China is providing fodder for bears as well as bulls. The stimulus program implemented in the wake of the global financial crisis has had side effects, including production overcapacity and a glut of products. The Chinese government is encouraging business to consolidate and scrap facilities, but it will be some time before reasonable levels are reached.

     This affects Japanese stocks such as Nippon Steel & Sumitomo Metal, which has lagged behind the Nikkei average's performance. "Interest from foreign investors has waned," said Takashi Enomoto at Merrill Lynch Japan Securities.

     The two main reasons for this development are both related to Chinese overproduction. Some worry that the Japanese company has been caught up in Asia's price wars over steel products, and that cheap products could enter the healthy Japanese market.

     Why are investors changing their minds about emerging markets despite China's persistent problems?

     "It's just that the excess of money from monetary easing moved to oversold assets," said Masamichi Adachi at JPMorgan Securities Japan. With the U.S. looking to bring its easing program to a close, the easy-money faucet will someday be shut off. If a country's economy is brittle, it rapidly becomes a selling target.

     This month, U.S. President Barack Obama nominated Ramin Toloui for the position of deputy undersecretary for international finance. Toloui has co-headed the emerging-market portfolio at U.S. investment company Pimco. His selection could be seen as Washington's preparation for global volatility stemming from emerging markets.