The ’emerging markets decade’ may be about to regain traction

(Bloomberg) – Emerging market bulls are still bullish on the asset class, even after China’s much-vaunted reopening rally failed and proved Wall Street’s optimism at the start of 2023 was misplaced.

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Assets in developing countries should finally take off in the second half, they say, as long as global interest rates peak, Chinese authorities will support growth and structural reforms in India will bolster sentiment. A recovery could yet make this the emerging markets decade that Morgan Stanley Investment Management flagged earlier this year.

“India, Brazil, China, they don’t have an inflation problem anymore, so they can cut rates faster than the Federal Reserve,” Xavier Baraton, global chief investment officer at HSBC Asset Management, told Reuters. Paris, on Bloomberg Television. “If you’re looking for real diversification right now, you need to look to a real EM. You have to look in Asia. You have to look at India, which is underestimated.

Although the first half of 2023 was not a disaster for emerging market investors, it fell far short of momentum forecasts.

The MSCI Inc. emerging markets stock index is up about 5% so far this year, well behind the nearly 11% gain in a gauge of developed peers. An emerging currency index, meanwhile, edged up nearly 2%. And emerging local currency bonds only narrowly outperformed a gauge of global debt.

What Bloomberg strategists say

It’s nice to see that there’s more to the life of investing than just buying ridiculously-valued tech stocks, and that you can get comparable or even better returns from alternative strategies with a value proposition. less obnoxious. If global inflation and monetary tightening have had a positive impact from an investment point of view, it is the revival of the good old EMFX carry trade.

— Cameron Crisis, macro strategist

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Among the factors holding back gains, China’s exit from Covid-Zero restrictions has not translated into much economic strength, instead boosting spending on services such as travel and restaurants, leading to weak growth in the economy. credit, a contraction in exports and a slowdown in home sales. The impact has spread to other markets that depend on Chinese demand such as South Africa and Thailand.

This casts doubt on the bullish view laid out by Morgan Stanley Investment Management in January: emerging market equities are set to be the winners of this decade amid attractive valuations and superior growth prospects, particularly in countries like India. .

Equity Opportunity

On the positive side, the disappointing numbers so far mean that some metrics are now identifying pockets of value in the emerging market landscape.

Benchmark equity indices are expected to rise in most emerging markets by the end of the year, with some of the biggest gains expected in Hong Kong and mainland China, according to analysts’ aggregate price targets compiled by Bloomberg. .

“The pessimism, particularly in China and Hong Kong, has been extreme and does not accurately reflect economic fundamentals,” said Greg Lesko, managing director of Deltec Asset Management LLC in New York. It favors consumer names likely to be supported by targeted Chinese stimulus.

“Alibaba, are ridiculously cheap and have tons of money, but have been hurt by US-China tensions,” he said. “Indonesian banks are money-making machines.”

Currency value

Many emerging market currencies could also strengthen as the Fed nears the end of a tightening cycle that has already been underway for more than a year.

“Assuming we are one or two ups away from the peak, then this headwind to EM currency performance should dissipate,” said Edwin Gutierrez, head of emerging market sovereign debt at abrdn Plc in London. “It will also psychologically pave the way for more emerging central banks to consider rate cuts in the months ahead.”

The lack of a clear driver has led to scattered performance among emerging currencies this year, while uncertainty over Fed tightening has boosted volatility. The Colombian and Mexican pesos both jumped more than 10%, while the Turkish lira fell around 20%.

The end of global rate hikes will help reduce volatility and support carry trade, which will benefit currencies and higher-yielding emerging market bonds, said Alvin T. Tan, head of currency strategy. Emerging Markets at RBC Capital Markets in Singapore.

“A more concerted return to carry trade would benefit the higher Latam and EMEA currencies even more, except for those under the spell of unorthodox policies, like the Turkish lira,” he said.

Debt of developing countries

There are also defenders of developing country bonds, as high central bank interest rates increase the appeal of higher-yielding assets.

“We expect an easing cycle to begin in a number of emerging markets in the second half of this year, starting with Latin American economies and then some Central and Eastern European economies,” Phoenix said. Kalen, Head of Emerging Markets Research at Societe Generale SA in London.

“There is room for there to be some thinking about pre-positioning these rate cuts, and room for rates to come back – especially given how high real policy rates are at the moment, especially out of Latam,” she said. said.

Yield-hungry investors have already piled into Indonesian bonds after the central bank all but ended its tightening cycle earlier this year, while its domestic coffers remain healthy thanks to the rally in commodities. Rupee-denominated debt has yielded around 11% in dollars this year.

Indian bonds also look attractive on the back of good growth, a potential rate cut later this year as inflation moderates, and a trade balance that “has never been better,” he said. Eric Lo, Asia Fixed Income Portfolio Manager at Manulife Investment Management in Hong Kong. .

What to watch

  • India is expected to say inflation slowed for a fourth month in May. The country’s central bank left its key rate unchanged last week

  • The People’s Bank of China will review its one-year term loan facility, while the country will also release retail sales and industrial production figures. Weaker-than-expected inflation data last week boosted expectations of a rate cut

  • In Latin America, Brazil will announce retail sales for April and Mexico will release industrial production figures for the same month

  • The Fed, European Central Bank and Bank of Japan will all meet in the coming week, which could also influence emerging market assets

–With help from Malavika Kaur Makol and Srinivasan Sivabalan.

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