Societe Generale’s Cross Asset Research published a report titled “EM Special” on Monday. In the report, SG analysts Benoit Anne and Eamon Aghdaal highlight the “great divide in views among hedge funds and real-money investors” on the current condition and future of emerging markets.

The “great divide” derives from the fact that hedge fund managers are more bearish than real-money investors (those who invest unborrowed funds) on most emerging markets despite the recent major correction, although the SG report indicates they are seeing the first signs of a change in sentiment among hedge fund analystsand managers.

Emerging Markets Try Under Severe market pressure EM

Emerging Markets RUB Victim EM

Real-money investor sentiment could be trigger

Anne and Aghdaal point out that their survey suggests that real-money investor sentiment itself could serve as a catalyst. “Most hedge funds inquired about potential real-money flows, and real-money investors themselves were eager to know what other real-money investors were doing. To us, this highlights the significance of technical factors in the current market environment, and evidence of real-money investor involvement was perceived by many as a major trigger for a potential market.”

EM – China a major theme

Nearly all SG clients surveyed responded that China was a “major consideration” and a key player to keep an eye on over the next few quarters. Interestingly, none of the interviewees were seriously concerned about a China hard landing. “On China, the general concern was more on growth performance and the worsening data than on the apparent fragility of the domestic financial system. But even on growth, virtually no one was concerned about the scenario of a hard landing.”

Doom and Bloom Scenario in emerging markets

Anne and Aghdaal also returned to the idea of a “Doom and Bloom” scenario, wherein after an extended emerging market correction (Doom), a major rebound (Bloom) follows soon after. “Doom and Bloom [EM] scenario discussion revolved around the potential triggers of the so-called Bloom phase. We argued that those triggers may first be technical in nature, for instance renewed appetite for emerging market, if volatility were to normalise. The participation of real-money investors, who tend to believe that EM valuations are now particularly attractive, would also be a decisive factor. Another important consideration is bearishness fatigue on the part of hedge funds, since quite a few of them appear to be running overstretched short emerging market positions. On the fundamental side, a strong policy response on the part of emerging market authorities could go a long way towards stabilizing market conditions.”

In concluding, however, the SG analysts warn that it is not clear that either the “Doom” has fully manifested, or that the factors required for a “Bloom” (including significant emerging market structural reforms) are fully in place yet.