Huge gaps in growth and interest rates have turned the flow of money from mature into emerging economies into a torrent, but the truism that some markets are riskier than others should give investors pause for thought.
Currencies and asset prices have hit multi-month highs in a broad swath of emerging markets, suggesting a degree of complacency in the finance industry that could, in some cases, exacerbate familiar risks posed by inflation, politics and trade imbalances.
"The thinking is 'out of West, into rest.' It's much more indiscriminate than what we've seen before," said Michael Power, global strategist Investec Asset Management in Cape Town.
"People will eventually have to wake up to the fact that emerging markets are not born equal."
A consequence of the ultra-low interest rates in much of the developed world, the wave of money heading to these markets is also part of a longer term trend precipitated by their relatively robust economic growth rates.
Record amounts ploughed into the asset class have sent the emerging markets equities benchmark to 2-1/2 year highs, up 14 percent this year, double its global peer's gains.
A second round of asset buying to be unveiled this week by the U.S. Federal Reserve could drive emerging markets higher.
But as witnessed during Asia's late 1990s crash, such investor optimism can evaporate quickly.
And evidence that a range of risk factors are being underplayed — from inflation pressures in India and rand strength South Africa to potential trade imbalances in Turkey and unorthodox fiscal policies in Hungary — suggests conditions are ripe for history to repeat itself.
The extra money pumped in by the Fed to spur economic recovery could also push commodity prices up, amplifying price pressures that many governments already strain to cope with.
India this week raised interest rates for the sixth time this year to try to tame stubbornly high inflation.
Runaway inflation threatens social stability in emerging economies such as Indonesia and Nigeria which tend to hold a larger proportion of their consumer price baskets in food.
Monetary policy slippages could upend the rally in emerging sovereign debt that has so far returned over 16 percent for investors this year.
"I don't think inflation is a risk that's fully priced into market now. There's a good chance that things become unmanageable a little while from now," said Bhanu Baweja, global head of emerging-markets currency research at UBS.
Investors could also be underplaying the risks in Turkey and South Africa, two of 2010's best performing emerging markets.
The lira is at its strongest in two years and Turkish shares hit historic heights late last month.
But the European Bank for Reconstruction and Development (EBRD) has warned that Turkey's current account deficit — some 6 percent of its output on an annualized basis — leaves it exposed to any reversal in capital flows.
Portfolio flows comprised the bulk of net capital flows into Turkey in the first half of 2010 while more stable foreign direct investment amounted to a mere 9 percent, EBRD data shows.
Turkish bonds yields are trading at historic lows after the central bank said it would hold rates steady until late 2011 in line with a dovish inflation outlook.
But the central bank has a patchy track record on inflation targets, observers say. The country also remains reliant on commodity imports and wage costs there are rising.
South Africa is also likely to struggle with inflation next year as wages rise as part of labor union settlements.
The strength of the rand currency, now trading at three-year highs to the dollar, is also hurting its manufacturing sector, making it harder for the government to wrestle down unemployment that stands stubbornly at a quarter of the labor force.
Consumer demand remains shaky and business confidence is slipping.
These stresses are barely reflected in market pricing: local shares are up nearly 10 percent this year.
"Flows are so strong that the market seems not to be concerned. But there are a lot of crowded positions at this stage. Investors will take any shocks badly," said David Hauner, fixed income strategist at BA-Merrill Lynch.
In Hungary, such flows have also cushioned markets from the immediate impact of controversial policies recently announced by the government to cut the budget deficit.
Led by the centre-right Fidesz party, which swept into power this year pledging to manage the economy based on "the popular democratic will," Hungary has spurned the International Monetary Fund (IMF) and drawn the ire of the European Commission with an unorthodox policy mix that includes the rechanneling of private pension fund assets to state coffers.
But the cost of insuring Hungarian sovereign debt against default has fallen to 285 bps from a mid-year high of 420 bps for five years while the currency has managed to rise 5 percent since July.
Local shares trade at a forward price-to-earnings ratio just above the 10-year average.
"There is sheer complacency in the markets now," said Luis Costa, emerging markets strategist at Citi.
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