PA ANALYSIS: Should you buy into the emerging markets rally?

Emerging market equities and bonds have outperformed their developed rivals by a large margin year-to-date, resulting in a surge in inflows.

PA ANALYSIS: Should you buy into the emerging markets rally?

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An acceleration in global growth and the absence of immediate macro concerns seem to underpin the current rally, but there are some obvious elephants in the room.

European equities are the unrivalled favourite with Europe’s investors at the moment, but global emerging market stocks come in second, with almost four in 10 fund buyers planning to increase exposure to the asset class over the next 12 months according to data from our sister title, Expert Investor.

While improving economic activity in the eurozone reinforces the case for European stocks, a resilient China does the same to (Asian) emerging markets.

And, as Blackrock noted this week, EM companies are positioned to deliver the highest earnings growth since 2010 this year, as are their counterparts in Europe.

“We remain positive on emerging market equities and Pacific ex-Japan, partly due to Chinese economic strength. Improving growth and moderate inflation across other emerging markets are also lending support to the asset class,” concludes Luca Paolini, chief strategist at Pictet Asset Management.

Alvaro Martin Sauto, head of funds-of-funds at Bankia in Madrid, is similarly bullish, as he sees Asian exporters profiting from the uptick in global growth.

“We have moved towards an overweight position in EM equities in the past three months. Emerging markets have been undervalued and quite unpopular in recent years, but that may well change as we expect GDP growth of 4-5% in Asia in 2017,” he says.

But the current economic acceleration may not be as durable as some investors believe, thinks Neal Capecci, co-manager of the Manulife Asian Bond Total Return Fund.

“Emerging markets have done so well because of the stability in China. China drives the bus, and most Asian [export-led] economies are tied to China.” he says.

The Chinese leadership is currently trying to ‘slow down the slowdown’ that resulted from its intended switch to a ‘consumer-led’ growth model, Capecci says.

“Chinese authorities have gone back to old methods, allowing more leverage into the system and taking temporary measures for the sake of stability. But this doesn’t mean China will expand in a meaningful way going forward.”

Part of the tailwinds for emerging markets may therefore fall away once China again reduces economic stimuli after the Party Congress in autumn. But China isn’t the only risk out there.

One may wonder whether emerging market investors still remember how they initially reacted to Donald Trump’s election in November last year.

The American president hasn’t yet followed through on his protectionist rhetoric, but many emerging market economies would be particularly vulnerable if he decides to do so. After their initial response, markets have quickly moved to discount this threat.

 

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