Will the rally in Emerging Markets Continue?

Fri, 24 Mar Pre-Open

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2016 has been a very good year for equities in Emerging Markets. The equity as an asset class snapped its negative streak and gave a return of around 11.2% in 2016. One of the key reasons has been the flow of the hot money from developed countries to Emerging nations.

What favors Emerging Markets over Developed counterparts?

First, EMs have started showing signs of growth after 2009 and Asia is set to remain biggest growth driver in the growth trajectory.

Second, valuations in the EMs are more attractive if compared to the developed markets after so many years of underperformance.

Third, Many EMs, especially outside Asia are coming out from recessions/downturns.

In fact, the falling interest rates in the developed markets and slowing of the economic growths also augurs well for the EMs.

However, the policies and stance of US's new president Donald Trump has raised the question mark on the performance of EMs.

Apart from the trade frictions, the risk of rising interest rates, faster growth and higher inflation in the United States can be a party spoiler for the Emerging markets. Historically, higher US interest rates have proved to be challenging environment for the EMs.

That said, if we look at the current scenario there are some positives building up for the Emerging Markets:

1. First, EMs has already faced significant outflows (in November 2016, after Trump was elected as the president, around $24 billion flew out of the Emerging Markets)
2. Second, the gap between the US interest rates and Emerging markets is quite high.
3. Third, US interest rates must rise at a faster pace to trigger largescale capital outflows because the current expectations are accounted for in the outflow so far.

The Bank of America Merrill Lynch (BofA ML) survey of fund managers has found that the net overweight stance of fund managers on emerging markets (EMs) has gone up from 5% in February 2017 to 18% in March.

This shows the market participants are still positive on the EMs over the developed markets.

We believe, the growth in the Emerging Markets and attractive valuations compared to their developed counterparts, makes strong case for them. The expected rate hikes in the US seems to be priced in.

It would be interesting to watch out any more than expected/steep hike in the Fed-rates, because that may result into a second round of sell off from the EMs.

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