Mike Dolan

LONDON (Reuters – It could be that investors in emerging economies can avoid another decade of dire times by proving they have done enough to prevent the tightening cycles at global central banks.

Everyone is bracing for the U.S. Federal Reserve’s first post-pandemic rate increase next month. It seems that clouds are gathering again over emerging economies.

For governments and businesses that borrow heavily in greenbacks, the prospect of rising U.S. Treasury yields is a double torture. It’s something few people in developing countries have managed to escape.

The outlook for emerging stocks is grim considering that the Fed lifted them from their last liftoff in 2013. This was before the 2013 so-called taper tantrum.

The positive thing about this situation is that most investors have already skedaddled.

According to a survey of fund managers by Bank of America (NYSE,:), the net 2% underweight in emerging market equities last month was due to a drop in funds’ position. This was an eye-watering reverse of the net 60% overweight that we saw in late 2020.

The pace of outflows has not slowed this year. EM funds were not spared from a wobbly year. Last week saw the 7th consecutive week with net outflows of emerging equity, and the 4th consecutive week with exits from EM bonds funds.

Despite all the negatives and pros of broad EM investing in the country, it is difficult to see a better situation for MSCI’s benchmark emerging stock index – which has now been almost half Chinese and Taiwanese companies.

The drama surrounding the pandemic has been exaggerated recently by China’s “Zero COVID” policies. While other economies have largely remained open through the Omicron version, the rising dollar interest rate and fractured geopolitics among the West, Beijing, and Moscow is unsettling like nothing before.

It was even worse when China’s debt-laden real estate sector nearly collapsed. The government also cracked down on China’s tech giants in its push for “common prosperity”.

The investment community was left on edge by a potential Russian invasion of Ukraine. This standoff last week appeared to strengthen the China/Russia alliance against NATO and G7, exacerbating the energy crisis and putting pressure to raise U.S. rates.

(Graphic: Emerging Markets Central Bank Rates, https://fingfx.thomsonreuters.com/gfx/mkt/dwvkrjyznpm/One.PNG)

(Graphic: EM indices relative performance vs since 2013’s ‘Taper Tantrum’, https://fingfx.thomsonreuters.com/gfx/mkt/zjpqkamylpx/Two.PNG)

DARKEST BEFORE THE DAWN?

Many believe that the darkest hours will be before dawn. Or that EM can win when value stocks’ are defeated. However, even extreme positions offer opportunities. This has led some to call for the return of emerging equity in an odd time.

The People’s Bank of China is bucking the global trend of easing central banks with its own easing.

Some others believe that a 18% peak-to-trough drawdown of MSCI’s equity benchmark has occurred over the last 12 months. A ‘bear-market’ signal is not warranted in the event there’s a decline of 20%.

Many believe that emerging companies must benefit from the pumped-up oil and commodity prices, driving decades-high global inflation rates. However tech stocks now have a larger overall weighting than all other sectors.

Tech stocks do not like high yields.

An even more convincing hope is the fact that central banks in emerging markets have managed to avoid the imminent bullet of a rising dollar against their currencies and tightened sharply ahead.

Brazil, Chile and South Korea increased their policy interest rates by nearly 9 points each to 10.75% in the last year. Chile also raised its rate 5 points to 5.5%.

It is possible that if the pre-emption reigns in the dollar during this Fed hiking cycle, and China continues its ease, it will allow emerging central bank to stop tightening sooner. That could offer attractive opportunities to bond investors who are afraid of what fixed income in developed countries has in store.

It’s an incredibly large ‘if’ that goes against all consensus opinions on the Dollar for this Year.

However, it speaks to another hope that the emerging economy model is moving away from an reliance on imports and towards more domestic drivers of demand.

Dara White from Columbia Threadneedle, head of global emerging equity at Columbia Threadneedle said “Emerging market are breaking apart from their dependency on the developed World.”

“Investors must now see emerging markets through another lens,” he said.

Is it the end of an era? We will see what happens after March.

(by Mike Dolan. Twitter (NYSE): @reutersMikeD. Editing by Alexandra Hudson. (NYSE):