Be Wary Of The Enormous Flows Into Emerging Markets Funds (EEM, BP)

This will probably be the year that interest rates around the world — in Asia, in Europe and maybe even the United States — go back on the rise. The question is how markets react.

This week alone, China raised its lending reserve requirements, the European Union inched closer to raising interest rates and central banks like Seoul are already ratcheting up their borrowing costs to fight inflation.

With signs of real CPI in the United States, it looks like the days of zero interest rate policy around the world are rapidly coming to an end.

For emerging markets, stocks will probably end up rising if rate hikes are a byproduct of real growth. Look to see countries with solid GDP expansion continue to outperform in any reasonable rate policy situation.

Despite mixed data in the developed world, the overall macro picture supports this outcome. Industrial production numbers are strong and labor market conditions are improving.

That said, countries that are forced to import more inflation — in the form of commodity input prices — than their economies can support may have a harder time. This is the definition of “stagflation” in a nutshell.

The week’s biggest corporate news will probably focus on the final big story of last week: BP plc (NYSE:BP) and Rosneft (RNGZY) moved toward announcing a major tie-up Friday afternoon, catching just about everyone off-guard. (Click here for subscriber-only analysis.)

This is a far cry from a few years ago, when BP was busy getting thrown out of Russia via the expulsion of Bob Dudley, who at the time ran BP’s joint venture with Russian insiders. Now Dudley is running BP and, after the fallout in the Gulf, has been courting Rosneft to unlock new sources of growth well away from the United States.

Fund Flows: Be wary of the enormous flows into emerging markets funds. This is not necessarily a technical sell signal — obviously, as all the weeks of rising flows and rising stock prices have demonstrated — but this money is mostly coming from retail investors.

Retail moves into ETFs and big mutual funds are nice, but generally lack conviction. Ideally, you want to be where the pensions, endowments and hedge fund community is playing, and right now these big institutions are getting a little lost in the froth.

These flows will remain sticky and will keep supporting the big asset-class-level beta plays like the iShares MSCI Emerging Markets ETF (NYSE:EEM), but the “whimsical” nature of the retail market is a concern for all of us who play here every day.

Written By Tim Seymour From Emerging Money

Emerging Money provides insightful and timely information about the increasingly important world of Emerging Market investments. CNBC Emerging Markets Contributor Tim Seymour leads the team of Emerging Money to bring you cutting edge global news and analysis.

About Tim Seymour: Tim is a founder of Emerging Money. He is a founder and Managing Partner at Seygem Asset Management, and The Emerging Markets Contributor to CNBC. Seygem Asset Management focuses on investing throughout the global emerging markets asset class. With a view that emerging and developing economies will continue to outpace the economic growth and advancement of developed economies, Seymour has devoted a career to investing in the dominant markets of tomorrow, today. Seymour’s career has included significant experience in both alternative asset management (hedge funds) and capital markets, having launched two hedge funds, and built the largest Russian broker dealer in the USA. Seymour started his career at UBS, focusing on international credit (cash, swaps, forex) in a specialized hedge fund group (New York). Seymour completed the firm’s training program after graduating with an MBA in international finance from Fordham University. Seymour received his undergraduate degree at Georgetown University.

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