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Outlook for EM and global backdrop

The Emerging View

11 May 2017

Emerging Markets (EM) asset prices over-reacted to the downside in recent years, especially given that EM fundamentals held up far better than expected in the face of serious headwinds. EM fundamentals are now improving in absolute terms and relative to fundamentals in developed economies, so EM asset prices offer exceptional value. Global asset allocators are beginning to recognise the opportunity by swinging resources back in favour of EM. 2017 will be the first year since 2013 with net positive inflows to the asset class. Asset prices and currencies are increasingly overpriced relative to risks in developed markets. The Dollar has begun a longer period of weakness as US growth slows in the context of excessive debt, lack of reforms, low productivity, an overvalued real exchange rate and gradual monetary tightening. EM local currency bonds are likely to be the best performing fixed income market in the world over the next five years with returns up to 50% in Dollar terms. Inflows into local markets are especially important because they help to reverse the financial tightening of recent years. This will further boost growth as well as improve public finances, increase equity earnings and justify tighter spreads on Dollar bonds. The main risks within EM are likely to be country-specific and idiosyncratic and therefore, best mitigated with active management. Events in developed markets are likely to be the most important source of volatility for EM as an asset class, but since the fundamental impact tends to be very low, investors should systematically buy into big bouts of volatility.

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