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Last year emerging market stocks fell by nearly a quarter. But in 2019 it has been a different story. The benchmark MSCI Emerging Markets Index has gained 13%. Chalk it up to “a new liquidity environment”, say Will Denyer and Udith Sikand of Gavekal Research.
“Tighter US dollar liquidity made 2018 a terrible year for risk assets.” When US interest rates are rising and the dollar is strong, money tends to flow out of traditionally risky assets, such as emerging markets, and into US securities with rising yields.
But for now, the market is expecting “abundant liquidity” for the rest of the year, given that the US Federal Reserve has paused interest-rate hikes and is set to pause its quantitative tightening (QT, the reversal of its money-printing programme). The European Central Bank has been dovish too, and intends to keep rates low for longer. In short, monetary policy is no longer a headwind for emerging markets.
China will provide a boost
It also helps that Beijing has been stimulating the Chinese economy following last year’s downturn. Trade talks with the US have bolstered confidence too. With the business cycle in the world’s biggest emerging market set to turn up, and growth rebounding or looking solid in other major developing economies such as India and Brazil, GDP and earnings should climb. Morgan Stanley is pencilling in year-on-year GDP growth of 5% for emerging markets by the end of the year, up from 4.3% in the first quarter of 2019.
Inflows have picked up and emerging market equities are “repeatedly mentioned as sectors investors feel comfortable allocating towards”, says Andrew Sheets, a strategist at Morgan Stanley. That’s partly because appealing valuations come with the improving outlook. Forward price-earnings ratios of around 12 are a tad above their ten-year average, but cheap compared with most developed markets.
Positive structural change
Investors will also be encouraged by longer-term changes that make emerging-market assets more attractive. One is governance. An increasing number of emerging markets have central banks that operate under a rules-based framework, Randolph Wrighton, managing director at Barrow, Hanley, Mewhinney & Strauss, told the Financial Times. Out of 20 emerging markets he covers, 19 have central banks and operate under rules-based frameworks, up from three only two decades ago.
The same number of countries now have limits on government debt and spending. In recent years current-account, or external, deficits have declined, which makes countries less vulnerable to downturns.
In addition, the long-term drivers of emerging market growth have shifted from commodity-driven sectors to consumption and technology. After peaking at 40% of the emerging market equity universe in 2008, commodities now make up less than 15%, while technology and consumer sectors comprise over 40%. These days, then, there is far more variety within the long-term emerging market growth story.