Monday, July 13, 2009

Emerging Markets and Dumb Money

Fund My Mutual Fund details (hat tip Abnormal Returns):

Stock markets of developing countries like India and Brazil have gone through the roof since early March, reversing some of their declines from last year. The MSCI Emerging Markets Index is up about 34% for the first six months of the year, after losing 54.5% in 2008. Some niche markets have had wilder swings. Russia’s benchmark RTS index is up 56% for the year’s first half, after losing 72.4% in 2008.
The chart below shows the three month rolling performance of the iShares MSCI Emerging Markets Index ETF (EEM). After last Fall's massive free fall, the ETF has performed exceptionally well.

But has it gone too far, too fast?

Fund My Mutual Fund thinks investors should beware. Along with the thought that current valuations may have rebounded ahead of fundamentals, there is another concern. Dumb money.
If you've been around these markets for a while you generally know by the time the retail investor is piling into a group, chasing huge scores - it's generally time to run away (at the least) and for the 5% among us who short, begin to think seriously about betting against the small fry. It sounds cold, but this is just the way it tends to work ... trust me, I used to be one of these people, so I learned the hard (read: expensive) way. As we read the piece below let us trust in the fact that none of these people were buying in early March, but most likely jumped in when it was "safe" a month or so later.
And jumped they have:
In the first five months of this year, investors poured a net $4.9 billion into diversified emerging-market mutual funds, more than reversing the net $2.6 billion they pulled out in all of 2008, according to Morningstar Inc.
There have been numerous studies on "dumb money". One such study by Andrea Frazzini and Owen Lamont Dumb money: Mutual fund flows and the cross-section of stock returns concludes:
That on average, retail investors direct their money to funds which invest in stocks that have low future returns. To achieve high returns, it is best to do the opposite of these investors.
So, the next time you hear from your neighbor about the next big thing, think twice. Or just bet against them...


Bloomberg ran a story this morning about the valuation of Emerging Market equities and while the analysis is different, the result is the same...
The last time stocks in developing countries got this expensive was in October 2007, just before the MSCI Emerging Markets Index began a 12-month tumble that erased half its value.

The MSCI gauge trades at 15.4 times reported earnings, compared with 14 for the Standard & Poor’s 500 Index, according to weekly data compiled by Bloomberg. When developing nations last commanded a premium, the 22-country benchmark sank 54 percent in the next year.


  1. The problem I have is there are way too many people bearish still.
    The Association of American Individual Investors’ weekly sentiment survey had the bulls at 28% again which was at the March lows.

    So retail investors are pouring in but the bullish readings are only as high as they were in March.
    So many so called contrarians were saying the bull market was over in 2004, 2005, 2006. Retail investors were pouring in then aswell. We dont really know what will happen. Predicting is difficult and I dont know of many who have mastered it consistently over the last 100 years no matter how many crazy tools they use.
    The margin of safety over bank interest is generally 200-300% across the whole market at the moment.This was near zero at the peak.
    I hear from businesses sales are begining to pick up, dont be suprised if you see alot of profit upgrades in the reporting season.

  2. Always good to hear alternative views. Thanks...

  3. The real dumb money are the Mutual Fund managers that bought large blocks of shares at CIT on Jun 30! IJIOTS