Emerging Markets (GOP, Countries = EM) stocks, the partial easing of global inflation and the hope that the U.S. central bank will soon slow interest rate hikes have led investors to invest in the asset class, according to the Financial Times report titled “Emerging market stocks jump 20% from October low”. It rose more than one-fifth from its October low.
The MSCI GOP Stock Index rose more than 21 percent from its intraday low on October 25, according to data from research firm Refinitiv. A 20 percent increase from the lowest level in the cycle is considered a bull market.
The optimism came after a painful period between February 2021, when the MSCI GOP stock index fell more than 40 percent, and late October last year. Last year’s hefty Federal Reserve rate hikes and the strengthening US dollar pulled money from risky assets, including emerging market equities and local currency bonds. Mutual funds that have purchased such assets have withdrawn from their GOP holdings at record levels in 2022 by November. According to the uncertain data in November and December, hot money turned to the GOP again.
Bank of America Securities strategist David Hauner said last week’s ISM and PMI surveys, which showed a decline in activity in the dominant US services sector, raised expectations among investors that the Fed will raise interest rates this year less than previously anticipated.
“There is a growing belief that EM can outperform US financial assets,” he said.
GOP assets such as equities, currencies and local currency bonds tend to perform well when US interest rates are low and the dollar is weak.
External conditions, such as US monetary policy, often have a greater impact on EM asset performance than domestic market conditions. The disruption caused by the pandemic and the Russian invasion of Ukraine has hit some emerging markets particularly hard.
Paul McNamara, investment director at GAM Investments, said emerging market stocks and bonds, like other risky assets, are driven by Fed policy.
“If the Fed retracts its rhetoric about high interest rates and we see inflation start to turn down from its peak, it will be a strong combination that attracts hot money to the GOP,” he said. “However, little is happening to justify new investments in the EM specific,” he added.
That said, investors see good reason for optimism in the Chinese economy, which will likely see a rebound in activity this year as the worst impact of the abrupt lifting of the government’s zero-Kovid policy restrictions. An increase in Chinese production is generally good for other developing countries, which provide many commodities and other inputs that China needs.
Chinese stocks, the biggest weight in the MSCI EM index, have risen sharply since the fall: the country’s MSCI sub-index in US dollars has risen more than 45 percent since Oct. The more widely followed CSI 300 index also rose 23 percent on the same basis. Markets in Taiwan and South Korea also posted strong gains during the period.
McNamara said that the recent drop in natural gas prices below the pre-war Ukraine level would also be good for some emerging economies, especially major energy importers like Turkey and the countries closest to Russia.
But BofA’s Hauner said that while emerging market funds were right to see low inflation and US rates as a positive signal, it would be wrong for them to ignore the negative effects of the slowing US economy. Weaker-than-expected U.S. employment and other leading indicators, including an inverted slope of the U.S. government securities yield curve (the difference between short-term and long-term Treasury yields turned positive in favor of the former), “marks one of the worst recessions in decades,” he warned.
“Fund managers are fully conditioned to the idea that central banks will always support markets that take excessive risks – a sizable proportion of respondents have never seen anything different in their careers,” he said. “However, we are heading towards a very sharp economic recession. There will be no soft landing this time.”
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