Money is fleeing emerging markets en masse in 2015 for the first time in 27 years and few global investors are tempted to return to equities, currencies or bonds there as many of the populous economies defining the asset class slow inexorably.
Over the three decades or so of the modern 'emerging markets' securities industry, periodic shocks and sharp drawdowns have typically been followed by big returns for those bold enough to snap up cheap assets during the darkest moments.
But this episode - seeded by fears of tighter U.S. credit and a rising U.S. dollar alongside a commodity collapse accompanying a secular slowdown of China's economic growth - has a different feeling and there's been a slow bleed for more than two years already.
According to world's most closely watched monitor of capital flows to emerging markets, the Institute of International Finance, the developing world will record net capital outflows this year for the first time since 1988.
Funds fear that instead of widespread defaults and currency collapses, the crisis this time is more measured and slower moving, and many of the over-investment and over-borrowing problems may take many painful years to correct themselves.
The market rally of the past week - sparked by expectations of another delay to U.S. rate hikes as jobs growth slows - is therefore seen fizzling out again soon.
"At several points in the last year-and-half I thought we were turning a corner and of course we haven't. We see these blips of out performance, then it continues on its downward trend," said Jose Morales, CIO of Mirae Asset Global Investments.
The reason, according to Morales, is the close correlation of emerging equities with the growth premium developing countries enjoy over richer peers. This premium, UBS data shows, has shrunk to the narrowest since 1999.
"I look at forecasts, not just for GDP (gross domestic product) growth but also earnings growth in emerging markets. I will start to believe that perhaps we are at a turning point when I see those downgrades stabilize," Morales said. "It always goes back to growth."
One big problem is the uncertain outlook for China, on which emerging markets' fortunes mostly hinge. Growth is very likely less than the official 7% while a $1.1 trillion buildup in company debt has raised fears of a financial crisis.
Emerging exports too are declining year-on-year at the sharpest rate since 2008-09, UBS data shows, a consequence both of China's slowdown and fragile demand from the West.
All this has made emerging markets cheap. MSCI's emerging equity benchmark is in its fifth year of underperformance versus developed peers and its price discount to developed peers is the widest in at least a decade. http://link.reuters.com/gup54w
Real exchange rates - measured against the currencies of trade partners and adjusted for inflation - are below 10-year averages for 12 out of 23 markets shown in this graphic: http://link.reuters.com/vuf47v
Not cheap enough
But "we don't want to be the ones to try and catch a falling knife," said Pierre-Alain Wavre, chairman of Pictet Wealth Management's investment committee. "We think some of these countries are in a vicious circle."
Wavre named Brazil as a prime example: once booming at 7% a year, the commodity-heavy economy is in recession and political impasse is blocking reforms.
Most fund managers polled by Reuters agree with Wavre.
"We would consider an investment only once growth perspectives have stabilized. Valuation is a long-term indicator but will not give signals for the short term," said Nadege Dufosse, head of asset allocation at asset manager Candriam Dufosse.
Similarly, a Bank of America/Merrill Lynch survey showed investors holding a record 40% underweight on emerging stocks in September, relative to global index weight.
A separate BAML poll of U.S. funds found over half had cut emerging debt allocations in the past quarter.
About 40% said emerging markets recovery hinged on commodity prices stabilizing. But over a third expected commodities to fall another 10-20% in the coming year.
Debt and earnings
At the heart of the crisis lie emerging market companies.
Slowing growth has pushed earnings-per-share 25% off 2011 peaks, the longest recession ever for MSCI's emerging index, according to Morgan Stanley. Earnings recessions after 1998 and 2008 were more brutal but lasted only 18-24 months.
Private companies have also racked up a mountain of debt, estimated by the IIF at $24 trillion. Of this $3.3 trillion is dollar borrowing, double 2008 levels.
Most countries have the means to step in and bail out corporates, but they can't afford to weaken their currencies for fear of causing defaults among corporate dollar borrowers.Morgan Stanley analysts said the process of unwinding leverage built over years has only just started.
"We need cleaner balance sheets to get structurally constructive," they added.