Friday, February 4, 2011

The Next Bubble is Emerging Markets?

There is a school of thought that sees investment as merely a game of hunting out the next asset class bubble and then following it, before trying to jump off when the inevitable bubble bursts. I think the process of how this works was best articulated by George Soros in 'The Alchemy of Finance'. 

In short, asset prices rise in response to a fundamental based trigger. This causes a lot of attention and then the fact that the price is rising than becomes a driver for more earnings growth. This may appear to be an abstract idea, but I have found it to be realistic. The process works in many ways, one example being the ease with which companies with high share prices can then get funding by selling stock. Anyhow, I digress!

The point is that that this process inevitably collapses when a 'tipping point' is reached which means the price no longer keeps rising and suddenly the drivers collapse. Furthermore, much of this process is about how sentiment favours an asset class.

The dotcom bubble scared investors out of equities. They then moved onto housing, gold, hedge funds, emerging markets and commodities. In other words, anything but Western equities. US housing has now fallen to the periphery of investor interest and hedge funds proved not to be 'hedged' in 2008. I'm not convinced commodities are out of favour and I'm sure the gold bubble will blow up at sometime.

The strongest candidate seems to be emerging markets and no, I don't know when the bust will occur. However, what I do know is that Portuguese 5 year CDS....

One-Year Chart for PORTUG CDS USD SR 5Y (CPGB1U5:IND)

....should not be priced more expensively than Egypt 5 year CDS

One-Year Chart for EGYPT CDS USD SR 5Y (CEGY1U5:IND)

 In other words, it is cheaper to insure default against Egypt's debt than it is for Portugal's!

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