Emerging markets are being tipped to see strong inflows in the second half of this year, with investors likely to view them as the lesser of three evils.

The sovereign debt crisis in Europe, the US fiscal debt situation and inflation risks in emerging markets have left investors at a global crossroads.

Yet in terms of which set of problems are easier to resolve, the simple answer is emerging markets, says Sandeep Malhotra, chief investment officer and head of global investment solutions at Clariden Leu.

“These [EM problems] are the normal problems of business cycles, they are not structural issues that will stick around for years or even decades in some cases,” Malhotra tells AsianInvestor over lunch in Zurich.

“On the equity side, it [allocations to EM] will be about seeking growth and appreciation, while on the debt side the question is, would you prefer to own the debt of, say, Italy or Indonesia?

“Clearly there is a credit-worthiness question that has been raised for Italy, but not for Indonesia because it has lots of resources. These are the kinds of questions that will lead to more flows into emerging markets.”

Malhotra acknowledges the emerging world has its own problems, with doubts still in play over a potential hard landing in China and fears about a further rise in property prices driven by the recent credit boom.

“The investment component of [China’s] GDP is unsustainable,” he says, “because the consumption component has to deliver stronger growth.

“You also have a credit bubble building up in Brazil, we’re talking about double-digit growth, but it does not look like that country will collapse any time soon. Of course, India also has an inflation problem.”

But he argues that the depth of the debt crisis in Europe (which he believes would be helped greatly if Europe designated just a handful of key spokespeople to discuss it publically) and the US fiscal debt situation carry far graver concerns.

While he expects the US to avoid default by hook or by crook before the August 2 deadline, “essentially it will not solve the structural problem of rising deficits and ballooning debt. That will remain an unsustainable situation.”

He suggests that the liklihood of a QE3-style intervention has risen after the US released its latest set of payroll numbers.

“The question of the reacceleration of the US economy in the second half is still very open and I am not convinced there is a roaring second-half waiting to materialise,” he adds.

“You could have a situation where the Fed anchors the 10-year yield on US Treasury at, say, 3%. That is a form of QE3, where they keep a lid on long-term rates. That has a lot of potential ripple effects if not contained.

“But hopefully the US debt situation gets resolved before then because if it doesn’t then we are going to see a big spike in rates, a massive fall-out in the US government bond market and also in the US currency.”

But Clariden Leu’s base case for the next 12 months is that worldwide growth will continue and that the global economy is not headed into another recessionary period.

“If there is a return to risk in the second half of this year, I think we will see some other potentially strong flows into emerging markets again,” he concludes.