“Despite a tumultuous two years that have included a financial crisis in Argentina, a recession in the U.S. and a war in Iraq, emerging-market bonds have been a hot spot for investors,” writes Craig Karmin in today’s Wall Street Journal.

“That might be about to change.”

“Even analysts who once touted them now worry that emerging-market bond prices may have soared too far, sending yields sharply lower, and that an accelerating global stock-market rally is starting to dim their appeal. ‘It’s very difficult to justify buying into this market,’ says Christian Stracke, an emerging-markets analyst for the research group CreditSights.”

“During much of the recent global market slump, emerging-market bonds were standouts, yielding as much as 10 percentage points above U.S. Treasurys at the end of 2001. From that time, Russian bonds have returned 66%, while Mexico is up 29%, and Brazil has gained 38%. But the recent turnaround in stocks, buoyed in part by signs of a U.S. economic rebound, has given investors fresh alternatives.”

“One result: a cooling of investor interest in emerging-market bonds to the point that money flowed out of the funds during one week in May, the first time that has happened since January.”

” ‘A lot of investors are not sure how much is left given the size of the rally,’ says Brad Durham at EmergingPortfolio.Com Fund Research. With emerging-market stocks rebounding in recent weeks, ‘there’s been a bit of rotation of money into emerging-market equities.’ He notes that Latin America stock funds have seen inflows in eight of the past 10 weeks for a total of $95 million; Asian stock funds, excluding Japan, have enjoyed three straight weeks of accelerating inflows, totaling $206 million.”

“The shift comes as yields over U.S. Treasurys for bonds from a number of countries — including South Africa, Morocco, Bulgaria and Poland — are at their tightest levels ever, suggesting the market is ripe for a correction.”

“The fresh round of skepticism could mark the end of a powerful, if sometimes volatile, rally that dates back to 1998, following Russia’s debt default. Since then, the J.P. Morgan main emerging-market bond index has surged 134%, including a 19% gain this year. A series of economic overhauls, a slowdown in the amount of borrowing, and high interest payments drew investors in search of higher-yielding securities.”