Emerging Markets Stocks Are on a Tear After Federal Reserve’s Rate Increase

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  • Central bank tightening sends signal global growth rising
  • Developing stocks up almost 6% in longest rally since August

The strength of a rally across developing nations after the Federal Reserve’s rate increase has become a riddle for global investors. But the answer may be simple: growth prospects.

While higher U.S. borrowing costs typically boost the dollar, policy makers were less hawkish than investors expected, sending the greenback tumbling and emerging-market assets soaring. That gave investors breathing space to revel in the prospect of faster U.S. growth — because when the world’s largest market takes off, it lifts the fortunes of countries worldwide.

“The global recovery is getting stronger and even Europe is showing some signs of life,” said Hertta Alava, the head of emerging markets at FIM Asset Management Ltd. in Helsinki. “There was a little bit of weakening at the end of February, but investors are back in the game. This environment is good for risk sentiment.”

Developing-nation stocks are on longest winning streak in seven months, and Mexico’s peso and South Africa’s rand led a measure of emerging currencies to the highest level since 2015. The iShares MSCI Emerging Markets ETF, an exchange-trade fund that tracks developing equities, saw inflows of $197 million on Monday, the second in a week.

Chinese stocks and South Korea’s won starred in the rally since the latest U.S. rate increase. Most investors favor Asian assets for the rest of 2017.
“One of the reasons why we really like Asia and why we are overweight emerging markets is because we believe the fundamentals are now turning,” Belinda Boa, the Hong Kong-based head of active investments for Asia Pacific at BlackRock Inc., told Bloomberg Television. “There are markets that are running hot. What’s really important for us is for our investors to look at the medium to longer term.”

That echoes Christopher Brightman’s view. The chief investment officer at Research Affiliates LLC said investors have the opportunity to get in early on what should be a multi-year bull market in emerging assets as demand for commodities increases.

Here’s a look at various metrics that show the strength of developing assets:

Stocks

  • The MSCI Emerging Markets Index rose to the highest level since June 2015.
  • While that took its valuation to the highest level since October, or 14 percent above its five-year average, analysts have increased their average earnings forecasts for the gauge’s companies to the highest level since August 2015.
  • Chinese, Taiwanese and Korean companies accounted for seven of the 10 biggest contributors to the stock gains in the MSCI gauge since the Fed decision.
  • Analysts have raised estimates for dollar earnings at Russian companies to the highest level since 2014.
    • Russian assets are attractive as the country is recovering from a “bad economic downturn,” FIM’s Alava says.

Currencies

  • The MSCI gauge of developing-nation currencies advanced for a fifth day, the longest run this year.
  • Mexico’s peso and South Africa’s rand extended their status as the world’s best carry trades this year.
  • South Korea’s won was the biggest gainer among Asian peers since the Fed meeting as fund flows into the country increased. All currencies of developing Asian currencies rose during the period.
  • Concerns of a “hard landing” in China’s economy have eased after a raft of recent data sparked optimism that the rate of growth is picking up, Alava says, adding that she favors countries including India, Vietnam and Philippines, as they have “young populations” and their economies “have room to catch up.”

Bonds

  • The yield on a gauge of dollar-denominated government bonds narrowed by 19 basis points.
  • The iShares JPMorgan USD Emerging Markets Bond ETF gained $438 million of inflows in the four days through March 20.

Key Risks

  • U.S. President Donald Trump’s policies are the biggest risk for emerging markets, Alva says.
  • Capital Economics predicts the Fed will boost rates by a greater degree than markets anticipate, according to William Jackson, a London-based economist.
    • Jackson sees Turkey’s lira and industrial metals as the be most vulnerable to gains in U.S. borrowing costs.
  • “If we move into a more hawkish environment, we would anticipate that as a risk where we’ll see a stronger U.S. dollar and tightening financial conditions which of course would be negative for this part of the world,” BlackRock’s Boa says.
  • French elections will be watched for any sign that right-wing populists may be taking the upper hand, Jackson says.

 

Bloomberg

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