THERE is an increasing chorus of bears which regard the oil price drop and China crackdown on leverage – which spurred the rout in industrial metals and iron ore – to be potential killers of the emerging market rally.

But some are not convinced. “(Despite the drop), oil price is still near the acceptable range so long as it does not hover too far from US$50 per barrel. It may not affect the fundamentals of an economy too drastically and may just be a sentiment issue.

“Likewise, it is a sentiment issue on China leverage. Our data shows a gradual improvement of fundamentals in the Chinese economy – in Purchasing Managers’ Index (PMI), trade and exports,’’ says Areca Capital CEO Danny Wong.

The PMI is an indicator of the health of an economy and is calculated based on new orders, inventory levels, production, supplier deliveries and employment environment.

The bears warn of inflated valuations in emerging markets and that reduction in leverage will slow growth in other developing nations.

“Sell into strength,” Arthur Budaghyan, a strategist at Montreal-based BCA Research Inc, was quoted as saying by Bloomberg. “When the rally cracks in the weeks ahead, investors should establish short positions because the potential downside will be considerable.”

A short position is taken by an investor who sells shares of borrowed stock, expecting the price of the stock to decrease over time, when he can buy the shares and return those which he had borrowed. The four-month performance of emerging-market equities, adjusted for volatility, relative to commodities, is near record highs, according to Bloomberg.

Potential market killer?

“The likely slowdown in Chinese economic numbers over the next two months is more likely to be an emerging market killer. Imports and exports are already down. Its producer price index (PPI) is also trending down.

“China front-loaded its purchases from Asean,’’ says Etiqa Insurance & Takaful head of research Chris Eng.

China’s PPI in April rose 6.4% from a year earlier, according to Reuters, quoting the National Bureau of Statistics. It was slower than expectations for a 6.9% increase and had eased further from a gain of 7.6% in March.

April imports for China rose 11.9% from a 20.3% rise in March, it says, quoting official statistics. Imports missed expectations for an increase of 18%. Its exports rose 8% from a year earlier, from a 16.4% rise in the previous month and was short of expectations for an increase of 10.4%.

Do not be complacent

“Market complacency should not set in. While market volatility remains remarkably low, investors should be prepared for bouts of volatility and pullbacks,’’ says Socio-Economic Research Centre executive director Lee Heng Guie.

This is especially when new risks emerge; hopes fade on outcomes falling short of expectations; asset prices become unsustainable while credit growth and debt balloon. “Capital inflows have been sustained into equities and bonds of emerging markets as these markets appear to contain their vulnerabilities against higher US rates, a stronger US dollar and weak commodity prices.

“Markets appear more focused on the prospects of President Donald Trump’s reflationary policies and have shrugged off headwinds associated with the US Fed’s rate hikes, oil price falling below US$50 per barrel or the risk of trade wars.

“The latest (risk) is China’s move to crack down on leverage via the cleansing of zombie loans, restricting of mortgages and taming of real estate bubbles is a positive move to reduce financial system risk.

“That will also contain the negative spillover on the economy, should the huge debt bubble implode,’’ says Lee.

“The positive outlook for Malaysia is more related to the general belief that the economy had bottomed out last year and consumers are getting more enthusiastic on improvement in the labour market. The ringgit is also currently considered attractive based on its real effective exchange rate level. The corporate outlook is slowly improving as evidenced by a positive turnaround in Malaysian Rating Corp’s (MARC) rating drift (statistics on rating upgrades, downgrades and defaults), within MARC’s universe, in 2016,’’ said MARC chief economist Nor Zahidi Alias.

Lesson from IWC

The Iskandar Waterfront City (IWC) ‘fiasco’, in which the sale of land for the Bandar Malaysia project was aborted, has jolted investors back to their senses. Its shares tumbled upon the sudden news after surging more than 282%.

“Valuations should reflect the risks of possible problems and losses arising, and should not be so aggressive as to be priced for perfection. Some projects may get aborted, get into cost overruns or run into defects that become the subject of litigation.

“They may get completed but payments are not received. Or they get embroiled in disputes that halt work. Weather and foreign workers issues can disrupt work leading to late delivery,’’ says Inter-Pacific Securities head of research Pong Teng Siew.

Columnist Yap Leng Kuen has this feeling of déjà vu when it comes to inflated prices.