Albert Edwards: China hard landing will be big 2012 shock

Société Générale's perennial bear Albert Edwards has questioned the mentality of investors who have piled into emerging markets due to the lack of suitable alternatives.  

He warns investors could pay a severe penalty for this, pointing out Brazil and India appear to be slowing, while identifying a China hard landing as likely to be one of the biggest investment shocks next year.

'The crucial driver investors are missing is the change in global liquidity as measured by growth in EM foreign exchange reserves,' Edwards said. 

'Confidence often ebbs as growth slows and EM economies are seeing a sharp drop in reserves and liquidity tightening. In this context did anyone spot the chief economist of the China State Information Centre calling for a yuan devaluation now that reserves are falling (link). Shall we call this Investment Shock II?

He highlights that while investors have been preoccupied by the problems in the eurozone, the Brics [Brazil, Russia, India and China] have not exactly set the world alight.

'If you thought the eurozone has performed poorly this year, the Brics - which he dubs a "bloody ridiculous investment concept" - have done worse,’ 

He described the investor trend towards emerging market investment as just another 'superior growth fantasy' and said they need to recognise valuation is what is key with the developing world, not the apparent growth story.

Edwards believes this is another example of flawed behavioural patterns among investors. ‘Once investors get an idea into their heads it is very difficult to dislodge. “Equities for the long term” was the mantra for such a long time. But now, with stocks having underperformed government bonds on a 10-20-year view, equities have lost much of their lustre.’

Edwards said investors in concepts such as Brics tend to be 'suckers' for a good story when actually if they looked at the evidence ‘there is absolutely no correlation between investment returns and economic growth because investors overpay for growth stories and there is no margin for error'.

He said: 'The problem I find is that investors are desperate to believe the EM and Bric growth story, for they have so little alternative,' he said. 'The story of superior growth for the EM universe is as entirely plausible as it is entirely misleading. Valuation is what matters for investing in EM, not their superior growth story. Certainly EM equities are not relatively cheap.'