Taking IEEM as a measure of investor demand for the emerging markets sector as a whole, there has been a recent acceleration in buying. Over the three months to 12 November 2010, the fund had added over US$1.5 billion in assets, a record rate of growth for the fund as measured by a quarterly rolling total of assets under management.

Can this frantic buying of emerging markets continue, or are investors now risking capital by chasing the trend too far?

Several leading strategists have recently pointed out warning signs for those putting money into the sector, including the chief economist for the firm which has benefited most from the investor inflows, Vanguard.

As quoted recently in a Wall Street Journal article, the firm’s chief economist, Joseph Davis, argued that “it isn't a lock that emerging-markets stocks are going to outperform going forward”. When measured by a trailing price/earnings ratio, emerging market stocks now no longer trade at a discount to stocks in the US, Davis pointed out.

Michael Hartnett, strategist at Merrill Lynch, sounded a similar note of caution when reflecting on his firm’s latest (October) survey of investor expectations. Merrill Lynch’s survey is widely used as a measure of professional investors’ sentiment, and can be viewed from a contrarian viewpoint; if everyone is long a market, who’s left to buy?

Noting that a net 49% of survey respondents had moved to an overweight position in emerging markets, Hartnett said, diplomatically, that “while improved risk appetite is to be welcomed, one proviso is just how narrow the investor focus on global emerging markets is at this point."

From the perspective of many emerging market governments, a slowing down of this year’s incredible money rush would also be welcome.

Brazil’s finance minister, Guido Mantega, warned in September of an “international currency war” in response to the US Federal Reserve’s plans to adopt a second round of quantitative easing. Brazil’s government has twice put up taxes on capital inflows during the last year, in a bid to deter speculative buying of Brazilian equities and domestic bonds, which are in turn pushing up the value of the real. Meanwhile, China is clearly struggling with inflationary pressures as a result of hot money inflows, leading to a prospect of interest rate rises to slow down the economy.

Whether such government interventions can reverse the mad scramble by investors to buy developing countries’ shares, or whether the boom will subside and reverse by itself remains to be seen. But one thing is clear: it’s been a record-breaking year in emerging markets.

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