Magic Inflation Number in Focus as Buy Sign for Emerging Markets

(Bloomberg) -- Emerging-market investors weighing whether to flee amid warnings of a quickening march toward 4 percent U.S. Treasury yields have one number in their favor: 2.5 percent.

That’s the current rate of U.S. consumer price inflation. Why does that matter? Because developing-nation stocks tend to crumble when yields rise fast -- with one exception: When CPI is below 3 percent. The October 1987 crash, 1994 tequila crisis, 1997 Asian crisis, 2000 tech bubble and 2008 financial crisis all occurred when inflation exceeded that threshold.

Magic Inflation Number in Focus as Buy Sign for Emerging Markets

On average, emerging-market equities have rallied 26.3 percent during the past dozen occasions in which CPI remained below 3 percent, trouncing U.S. stock gains two-thirds of the time. In periods with CPI above 3 percent, developing-nation stocks fell an average of 4.5 percent and generated lower returns than their U.S. peers seven of 12 times.

"The real question is how quickly we get there," said Pedro Zevallos, a Santa Monica-based money manager at Dalton Investments, which oversees about $3.8 billion. "If it’s a measured pace to 3 percent, emerging markets should be all right. If you get inflation pressure building faster than expected, that’s a problem. It’s the paradigm of the taper tantrum."

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