Low interest rates and expectations for a global economic recovery have bolstered emerging markets lately, but strategists see reasons for less bullishness in the near-term, at least.
While still positive on emerging-market stocks,Bank of America‘s Hong Kong-based equity strategists Ajay Singh Kapur and Ritesh Samadhiya lowered their tactical allocation to cyclical stocks in Asia and emerging markets as some of the risks to the asset class gain momentum.
Those risks include the dollarbeginning to strengthen,which poses a challenge for emerging markets, especially those reliant on foreign funding. Also potentially worrying: With more than three-quarters of global money managers in BofA’s latest survey expecting a strong economic recovery, the potential for a surprise that bolsters markets has dried up, the BofA strategists write in a note to clients.
China, which accounts for almost 37% of the MSCI Emerging Markets index, though, poses one of the biggest risks to the broader index. Several strategists have been waryabout China’s moves to tighten credit; the ease of borrowing in China is often a leading indicator for global growth and cyclicals. Chinese regulators’increased scrutiny over big internet and technology companiescontinues to loom over the market, as well. Indeed, China’s stock market has been one of the worst performers so far this year. TheiShares MSCI Chinaexchange-traded fund (MCHI) is down 1.2% so far this year as other markets charge higher.
DataTrek Research co-founder Nicholas Colas is concerned about theChinese regulatory crackdownon technology companies, and also says history doesn’t offer an optimistic view for emerging markets when the Fed is raising rates. Emerging markets broadly could be under pressure as long as markets are worried about Fed rate increases and timing, he writes.
While emerging marketsmay not be as vulnerableto a 2013-like taper tantrum as the Federal Reserve begins to talk about dialing back its stimulus, BlackRock Investment Institute strategists also told clients in a note that any temporary spikes in rates could challenge emerging market assets.
That comes as a note of warning as investors looking for pockets of the market that haven’t priced in a global recovery completely search abroad. Money managers are still finding select opportunities in emerging markets, including in commodity-rich countries like Brazil that have largely fallen out of investors’ portfolios in recent years.
China’s efforts to stem the surge in commodity prices and inflationary pressures—including releasing strategic reserves and instituting overseas trading curbs—sapped some of the momentum from the commodities rally.
But Gavekal Research analysts see China’s efforts as a pause rather than derailing the move higher in commodities like oil andcopper,for which China is more of a “price taker” rather than a “price setter.” Data suggests stockpiles for these commodities are at their lowest levels in a decade, according to Gavekal analysts, who see the recent pullback in commodity prices as a pause rather than the end of the rally.
That could be good for select resource-rich emerging markets. For investors, picking spots within emerging markets will continue to be paramount. In addition to countries like Brazil that could benefit from continued demand for commodities, several tourism-oriented companies in southeast Asian countries—like Thailand—could benefit as the global recovery continues and vaccination rates in countries improves.