In a new report, Richard Bernstein at Richard Bernstein Advisors points out that investors are taking pretty big risks in their quests for higher yield.
Central banks around the world have kept monetary policy loose and interest rates low in their efforts to boost economic growth. This has caused conservative investors seek bonds in higher risk countries like those in the emerging markets.
One look at emerging market debt and you can see the gap “between perception and reality,” writes Bernstein. “Investors have been lured to these securities by their higher yields, yet the underlying economic and currency fundamentals are deteriorating without commensurate widening of spreads.”
Bernstein also points out that in the U.S. the current M2 (broad measure of money supply) growth rate stands at 6.2%, while the inflation rate is below 2%. “It is hard for us to envision abnormal rates of US inflation with the supply of money growing below average,” writes Bernstein.
Meanwhile, in a large chunk of emerging markets, including the BRIC nations, have money supply growth rates and inflation rates that are much higher than the U.S.
Higher inflation rates are bad news for bond investors whose income levels are fixed.
“Investors’ certainty regarding an inevitable increase in US inflation is somewhat puzzling because the US data has been remarkably benign,” writes Bernstein.
Inflation is just one of the many risks he sees in the emerging markets.
“The ongoing deflation of the global credit bubble will likely prove to be a significant and secular hindrance to emerging market growth, and investors still appear to be underpricing the risks associated with emerging market assets,” writes Bernstein.
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