Emerging markets were on the rebound Thursday after two consecutive days of decline, resuming a two-year rise and justifying the Street’s enduring enthusiasm.
"What it's starting to show is that the economies around the world are starting to do pretty well,” JJ Kinahan, TD Ameritrade's chief market strategist, told Benzinga. “The U.S. was the prettiest girl at the dance for a long time. It still is, but the other economies are improving around the world.”
The year started off well for developing economies. Short interest on the iShares MSCI Emerging Markets Indx (ETF) (NYSE: EEM) hit a year low, according to IHS Markit, and developing economy currencies struck their highest rates in nearly five years.
“Now, we have seen a total reversal, with people having a hard time even imagining how the market could decline,” Morgan Stanley said in a note. “We must admit the speed and relentlessness of the move is a bit troubling.”
Where Can The Markets Go?
Shahzad Hasan, an emerging-market debt manager at Allianz Global Investors, told Bloomberg he expects the assets rally to be stunted by inflation-related selloffs in U.S. Treasuries in the long term, but things look rosy for the time being.
"I am not worried about an EM selloff," Hasan said. "Valuations are stretched, but near-term EM spreads can continue to perform."
How Some Play The Trends
Mark Yusko, CEO and CIO of Morgan Creek Capital, said he sees great growth opportunity in emerging markets and anchors his portfolios accordingly.
“You don’t want to skate to where the puck is, you want to skate to where the puck is going,” Yusko said. “Today emerging markets account for 40 percent of global GDP, yet they’re only 11 percent of market cap. That just seems silly. So today in our portfolios, we’re heavily overweight, we’re closer to 40 or 50 percent emerging and sub-10 percent U.S.”
He leans on ETFs with preference for the specialty or country funds to EEM, which he considers more exposed to geopolitics.
“The only negative is people tend to use it for risk-on, risk-off,” Yusko said. “There will be a lot of times when the underlying RFX for Russia or MCHI for China or INDA for India are doing well, but EEM suddenly goes down because people are selling it, because they get afraid of North Korea firing a missile or Trump making a silly tweet or whatever.”
One particular region of interest is Japan, which has been strengthening over the last six years under Shinzō Abe. He advised hedging currency risk by investing in the WisdomTree Japan Hedged Equity Fund (NYSE: DXJ) rather than the iShares MSCI Japan ETF (NYSE: EWJ).
“What we love about Japan right now is this: it has the highest earnings growth of any developed market in the world, 40 to 50 percent year-over-year earnings growth; the currency has been stable; the economy is growing again — it’s been positive for the last five quarters; and their specter of deflation looks like it’s moving away,” Yusko said.
He also sees opportunity in the relatively cheap assets of China and Russia. In fact, Asia in general is attractively viewed.
Rob Subbaraman, head of emerging markets economics at Nomura, told Bloomberg he expects the region’s strong exports, tech-related investment expansion and generally loose monetary fiscal policies to foster a “sweet spot” of strong growth and low inflation in the first quarter.
Where Things Could Go Wrong
But this assumes stable global circumstances, which are always at risk.
Jean Boivin, head of economic and markets research at the BlackRock Investment Institute, said BlackRock’s indicators detect heightened and rising geopolitical risk for the year. It may not materialize in market volatility.
“Our base case is this will not materially affect the market, and if it does in 2018, it’s going to be temporary,” Boivin said on Bloomberg. “If there were to be a significant escalation in conflict, then it’s a different story, which I guess really isn’t the baseline.”
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