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Look! Hot Money Is Fast Exiting Emerging Stocks

Adam Jeffery | CNBC

Easy come, easy go. Hot money, or speculative capital flows, triggered by the U.S. Federal Reserve's ultra-loose monetary policy, is fast exiting emerging market equities, confirming worries over the negative consequences of such policies.

Asia's top performing stock markets including the Philippines, Thailand and Indonesia have erased a sizable portion of the year's gains, losing between 8 percent and 12 percent over the past two weeks, as concerns over the Federal Reserve's plans to scale back its bond-buying program triggered outflows.

"We are seeing the reverse of what happened over the past 24 months. So the outperformers are now giving back their outperformance over this short period of time. It's been hot money moving in, and now hot money moving out," said Sani Hamid, director, Wealth Management, Economy & Market Strategy at Financial Alliance.

The Federal Reserve's bond buying program has provided a steady stream of cash into emerging markets searching for higher returns. However, as the central bank prepares to pare back stimulus, investors are reassessing their positions.

(Read More: Stock Markets Tumble as Investors Bail on Risk)

"It shows how nervous markets are, and how central banks were behind the equity rally, everywhere in the world, Asia included. Everything has been driven by central bank policy, not by fundamentals," said Hans Goetti, chief investment officer at wealth management firm Finaport.

In addition to the Fed, which began its quantitative easing program end-2008, the European Central Bank and the Bank of Japan, most recently, have all eased policy to boost economic activity.

The sell-off in emerging markets has been evident across all asset classes including bonds and currencies. Investors pulled $1.5 billion out from emerging market bond funds in the week ended June 5, according to fund tracker EPFR, while equity funds lost $5 billion - their biggest outflow in almost two years.

(Read More: Emerging Market Funds See Biggest Exodus Since 2011)

Currencies including the Indian rupee and Thai baht have been hard hit – declining about 6 percent and 4 percent, respectively, against the U.S. dollar over the past month.

In addition to the prospects of Fed tapering, expensive valuations are also driving investors out of emerging market equities, said strategists.

The Philippines benchmark PSE Composite Index and Thailand's SET Index - which have gained between 40 and 55 percent over the past two years - are trading at a price-to-earnings ratio of 20 and 15, respectively compared with 9 for China's Shanghai Composite.

"The valuation in a number of assets is simply insufficient to compensate investors for the risk. Underlying macro fundamentals - growth, profits, external positions, credit, leverage and inflation have deteriorated in some emerging markets," said Nicholas Ferres, at Eastspring Investments.

How Fierce Will the Sell-Off Be?

While the MSCI Emerging Markets Index has declined 7.4 percent over the past two weeks, compared with a 2.8 percent decline for the MSCI All Country World Index, some experts believe losses will be limited from here.

"My guess is that it's nearing the end. We might see some jaw boning from some of the central bankers, in particular [Fed Chief Ben] Bernanke, to calm nerves. I think we're approaching the end of this part of the correction," said Robert Prior-Wandesforde, director of Asia Economics at Credit Suisse.

According to Mark Matthews, head of research Asia at Bank Julius Baer, many foreign fund managers are "torn" between selling down a market they like, or riding out further downside.

(Read More: Wild Swings? Emerging Currencies Have It the Worst)

Meanwhile, Goetti of Finaport expects emerging market stocks will trade in a "range bound environment" as a sell-off could encourage some bargain hunters, providing support to the market. After all, monetary policy is still accommodative, he added.

By CNBC's Ansuya Harjani

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