Analysis: global liquiditys U-turn to emerging markets

The yen’s liquidity has been a preoccupying subject for me recently. As the Bank of Japan pursues an aggressive monetary policy to tackle the earthquake crisis, Japan has emerged as a new source of global liquidity and concerns are waning regarding the possible about-face for the U.S. and European monetary policies.

Since October 2010, global liquidity has been flowing into advanced economies from emerging economies, reversing its previous trend. This decoupling of growth in advanced and emerging economies implies that the two have different macroeconomic conditions and different monetary policy stances. Ben Bernanke, the U.S. Federal Reserve Chairman, called this a “two-speed global recovery.”

The question is whether global liquidity will find its way back to emerging economies. Global liquidity has shifted from emerging economies toward advanced countries since October 2010. It is time to make a judgment call as to whether the money flow will remain as is or reverse to emerging markets. I believe emerging markets will be the next destination for global liquidity and a wise investor must take into consideration growth momentum in emerging markets for the following three reasons.

First, inflationary pressure in China and other emerging markets should peak in the first half of 2011 and subside afterward. Emerging economies have fallen out of favor mostly because they tightened policy measures to curb inflationary pressure. Commodity prices were the main culprit behind the mounting pressure. But a simulated analysis of the CRB futures index, a key gauge of commodity prices, shows inflationary pressure will quickly stabilize after peaking in May 2011.

Second, China, a leading emerging economy, has taken enough tightening measures. China’s M2 growth, a major indicator of money supply, is down to the government’s target of 16 percent. As M2 growth affects consumer prices with a time lag, prices will reflect the impact of monetary tightening down the road.

Third, emerging economies are showing greater tolerance toward their currencies appreciating. Chinese Premier Wen Jiabao said in mid-April the country would make its exchange rate scheme more flexible to rein in inflation. His comments indicate the RMB’s appreciation may accelerate. If such is the case, China does not need additional monetary policy tightening.

When policy tightening risks dwindle, the growth potential of emerging economies will have strong appeal to the market. Among others, China and its domestic demand merits attention. According to China’s GDP growth for the first quarter of 2011 released in early April, consumption made greater contribution to GDP growth than investment for the first time in decades. The statistics suggest China’s economy is shifting toward a consumer-centric paradigm at a faster-than-expected pace.

As such, I believe Korean companies that benefit from China’s growing domestic demand are promising investment targets. Based on the KIS Universe ― a basket of stocks that Korea Investment & Securities has created to mimic the broader market ― “buy calls” include leading China plays such as AmorePacific, Lock&Lock, Orion, The Basic House, CJ O Shopping and NCsoft.

Park Jung-je can be reached at jj.park@truefriend.com