'That Giant Sucking Sound?' Money Flying Out of BRIC

As lovers of U.S. stocks sit back, smile, and watch the S&P 500 climb higher and higher, emerging market investors are pulling their hair out. China’s Shanghai Composite is down 6 percent from November 2010 highs, Brazil’s Bovespa is down 9 percent, and (saving the best for last) India’s Sensex Index is down 10 percent.

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What happened to the world’s most dynamic, exciting, investment opportunity?

A “giant sucking sound,” that’s what. In the first week of February, investors pulled $3 Billion out of equities in the world’s fastest growing economies, according to EPFR Global, which tracks fund flows.

It was the third consecutive week of withdrawals from EM (emerging markets). The speed of the outflows is even more disturbing: money has been flying out of BRIC (Brazil, Russia, India and China) at the fastest pace since 2008, when risk was really coming off the table.

“Tactically, EM has not been the place to be for the past couple months because of inflation concerns,” said Michael Gavin, Head of Emerging Markets Strategy at Barclays Capital on The Strategy Session Monday. “The inflation concerns are exactly because these are high growth economies that are reaching the limits of their productive capacity, they need to tighten monetary policy. But that’s a cyclical, short term influence.”

If you’re a believer in India and Brazil long term—you can handle emerging market stocks overshooting to the upside when U.S. stocks are rallying. You can handle emerging market stocks overshooting to the downside when U.S. stocks are selling off.

That volatility is all part of the adventure of investing in the world’s burgeoning economic leaders.

What you can’t handle is a chart of the S&P 500 climbing 5 percent, as emerging market stocks sink 5 percent—as they have so far in 2011. That kind of directional divergence is rare.

It’s enough to make any believer a skeptic. Jay Pelosky, a one-time Managing Director at Morgan Stanley who created that firm’s first Global Emerging Market Product back in the 90s, is one such convert. “Emerging market equities have had a great run: 13 percent per annum returns for the last decade. So I think the game in emerging markets has effectively been played.” He thinks that if you want to really capture emerging market growth, ditch the local companies, and just by the S&P 500 (which, as an index, gets 40 percent of its revenues from abroad).

Still—technicians could point to classic, oversold conditions—perhaps approaching capitulation: according to Bespoke Investment Group, the Brazil ETF, the India ETN , and the China ETF are all more than 5 percent below their 50-Day Moving Averages.

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