LONDON Emerging market assets especially in Asia are likely to suffer further in 2012 as a slowing Chinese economy weighs on trade, boosting the dollar which would also benefit from the euro zone crisis, hedge fund manager Stephen Jen said on Tuesday.
Jen, managing partner of London-based SLJ Macro Partners, sees a 70-75 percent chance of some countries leaving the euro zone in the next year, while there is at least a 5 percent chance of Germany leaving the single currency bloc.
In contrast to long-held convictions, emerging market equities and currencies have underperformed their developed counterparts this year as capital flows seeking safety left risky assets.
"I'm worried about EM ... Even if it's a mild slowdown in China which is happening now, you could trigger an outsized move because the market is so one-sided, unhedged," Jen told the Reuters 2012 Investment Outlook Summit.
"I would be very watchful of high-beta assets, high-beta currencies of Australia and Brazil, EM bonds, equities, currencies. The potential for a very sharp move in favor of the U.S. dollar is very high in my view. I would say more than 60 percent probability. Investors are not ready for this."
The changing nature of China's growth from one reliant on exports would hit "beta riders," those who have grown off demand from China -- such as Australia, Brazil, Korea and Singapore.
"If the trade cycle slows more and China offsets this through fiscal transfers, then what generates 8 percent growth in China may not benefit Australia as much," Jen said.
"China has fiscal resources to save itself but it cannot save the others ... In Asia, there is zero upside risk. It's the least favorably positioned asset market."
GRAPHICS on global economy and financial markets: here
EURO ZONE BREAK-UP
Investors have been preoccupied with a series of emergency euro zone policy meetings to contain the two-year-old sovereign debt crisis but Jen reckons the problem is not a fiscal one.
"I think the EMU itself is flawed ... The origin (of the crisis) was monetary. If it were not for the EMU (European Monetary Union) causing the interest rate to be artificially low, you would not have had such severe credit bubbles," he said.
"The EMU will break up sooner or later ... Any form of reshuffling of the membership including the (Greece/Portugal leaving) scenario ... the total probability is about 70-75 percent."
He saw a "5 percent and rising" chance of Germany leaving the euro -- which would result in Germany having two currencies in circulation for a period of time afterwards.
"The least likely scenario is the smoothest scenario, and that's Germany leaving. All contracts in euros would stay in euros until they expire. There's nothing wrong with having two legal tenders -- Hong Kong has two," Jen said.
Italy, however, was likely to stay in the euro in either case and Italian debt at a yield of 6 percent may be attractive.
"In no case will Italy leave. It's one of the two extremes, Germany or Greece. Italy and France will never leave," Jen said.
"It is 3-1/2 and 4 percent real yield ... a lot of it is risk premium. Are you interested in 300 basis point risk premium? I think, if I had the time horizon and patience, I would be very interested."
(For summit blog: blogs.reuters.com/summits/; Additional reporting by Clare Kane; Editing by Susan Fenton; graphics by Scott Barber)