A businessman talks on his mobile phone as he walks in the financial area of Pudong in Shanghai, May 30, 2013. China has been the main driver of emerging markets outperformance in recent years, but prominent economists are now falling over themselves to slash estimates as the second derivative of Chinese economic growth rapidly declines.CARLOS BARRIA/Reuters
Credit Suisse has a good feeling about continental Europe and Japan, but isn't so bullish about the prospects right now for emerging markets.
In a research report this week, Credit Suisse upgraded its investment recommendation on continental Europe to "overweight" and downgraded its rating on emerging markets to "benchmark" - basically a neutral rating.
"We continue to see a risk that China's GDP growth slows to 6 per cent or worse and that the fundamentals of India, Brazil and Turkey look poor," stated the report.
With the currencies of nearly all emerging markets – with the exception of Chinese Yuan – falling this year, capital flight, higher inflation and slower growth are all potential risks.
Lagging commodity markets are also expected to hit emerging markets especially hard since, as the report notes, around 30 per cent of emerging markets profits come from the resource complex. That compares with 17 per cent for developed markets.
And with 30 per cent of emerging market economies operating at close to full capacity in the labour market, there's a very real danger of those economies overheating.
"Of the 18 emerging market economies, 13 have a greater overheating risk than all of the major developed market economies," according to the report.
Institutional investors have already started to take notice.
"Data from Credit Suisse Prime Services shows that hedge fund positioning on emerging markets is the most bearish it has been in at least four years," according to the report.
This isn't likely to come as a surprise to many Credit Suisse clients.
"In our conversations with clients we find that most are overweight U.S. equities and express skepticism about emerging markets – and in our latest client survey only 13 per cent of clients expected emerging markets to outperform, the lowest since our survey started in August last year."
But not all emerging market economies can be painted with the same brush.
Taiwan, China and South Korea appeared to be the most stable, according to Credit Suisse's "fundamental scorecard," with Turkey, South Africa and Indonesia rated as the most vulnerable.
"Overall, we conclude that emerging markets are likely to have a tactical bounce … but we believe that it is appropriate to take long-term weightings down to benchmark from a small overweight," reads the report.
Instead, Credit Suisse is putting more eggs in the European basket.
While the report noted that the European Central Bank's balance sheet contracted by around 20 per cent in the first half of 2013, Credit Suisse said they think it unlikely "that this pace of contraction will be maintained."
It even sees signs of improvement in embattled economies like Spain, Italy and France.
And with the German election only a couple months away, the bank sees potential for a "soft" debt restructuring of Portugal and Ireland. Credit Suisse is also now predicting a bearish future for the euro, which bodes well for a continental recovery.
"This lack of euro strength is critical given that 57 per cent of sales come from outside of Europe," the report said.