Emerging market equities: Emerging market equities are at their lowest, but the tide will soon turn in favor
But why should the tide turn, especially when the United States has already announced a roadmap to raise rates? Analysts believe the rate tightening is already built into current stock prices and that there is downside support for stocks beyond London, New York and Tokyo.
Granted, the MSCI Emerging Market Index fell 5 percentage points in 2021, while developed markets (DM) returned 20%.
The EM Index underperformed due to a ‘flight to quality’ in tough times which resulted in reduced exposure to risky assets and DM stocks were the preferred game of ‘reopening trade’ in due to a more rapid deployment of vaccines.
Concerns over emerging market equities were further rocked by the developed central bank which hatched a hawkish plot as inflation hit its highest level in 40 years in the United States and the central bank’s view on inflation towards the north has shifted from “transient” to “persistent”. As a result, the US dollar began to strengthen and the Bloomberg Dollar Spot Index gained 5% in 2021 – the largest annual gain in six years.
Traders took aggressive long positions in the US dollar before borrowing costs rose. Bloomberg data showed that hedge fund net long bets on the US dollar reached their highest level since June 2019 pending monetary policy tightening.
This would mean that the dollar gains will be moderate. The ICE U.S. dollar index – a measure of the currency against six currencies – is expected to rise just over 1% by the end of the fourth quarter of 2022.
Additionally, historical data suggests that the dollars traded firm in the six months leading up to the first interest rate hike.
Finally, the valuations of MEs reassure investors. The MSCI EM Index has traded the cheapest relative to the US Index since 2001. Valuation and earnings growth in the US is expected to peak in mid-2022; this may prompt investors to look to international equities for higher returns as emerging countries begin to live with Covid-19.
In addition, a few emerging countries have started to increase their interest rates; this could mitigate the impact on inflation and boost real returns on emerging market assets.
India has a weighting of around 9% in the EM index and overall the funds are neutral on Indian equities. Local stocks have started to underperform DM stocks over the past three months as central banks in developed markets have taken aggressive action to contain rising inflation, resulting in an outflow of nearly $ 5 billion. of dollars (38,000 crore) during the December quarter.
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