Fed Hopes, Oil Rebound Buoy Emerging Markets
Stock and currency indexes for developing countries have rallied, with investors drawn by cheap valuations in the wake of last year’s selloff Oil platforms operated by Lukoil are seen in the Caspian Sea. Surging oil prices have been a boon for Russia and other oil exporters.
A rally in some emerging-market assets has picked up steam in recent weeks, boosted by a surge in oil prices and expectations for a cautious Federal Reserve.
The MSCI Emerging Market Index, which measures stock performance, is up 4.5% so far this year, powered by gains in Russia, Mexico and other developing countries. A separate MSCI index that tracks foreign exchange stands near its highest level since the summer, thanks to rallies in the Brazilian real and other emerging-market currencies.
Investors often look to emerging markets—where many hope to garner bigger gains by assuming comparatively greater risk—as a gauge of overall market sentiment. The big drop in U.S. stocks last year was preceded by steep declines in the assets of countries such as Argentina and Turkey, as worries over Fed tightening and global growth dried up risk appetite.
Cheap valuations in the wake of last year’s selloff have been a key draw for emerging-market investors in recent weeks. Investors sank a net $26.6 billion into emerging-market equity funds in last year’s fourth quarter, even as they pulled $98.2 billion from funds focused on developed-market stocks, data from fund-tracker EPFR Global showed. The inflows have continued into 2019, with investors pouring some $2.1 billion into emerging-market stock funds in the week to Jan. 9.
Those bets are paying off early in 2019. Oil prices this month have clawed back some of last year’s steep decline, buoyed by easing trade worries and reports that Saudi Arabia would further reduce its crude-oil exports. That has been a boon for the assets of countries that export oil, including Russia and Brazil. Other commodities, such as nickel and palladium, have also climbed.
A further boost to emerging-market sentiment came earlier this month, when Fed Chairman Jerome Powell hinted that the central bank might not raise rates this year at the same pace it did in 2018. Mr. Powell’s comments mitigated the fears of investors who had worried that rapidly tightening monetary policy would stifle growth, while higher yields on U.S. government bonds would dim the allure of emerging-market assets.
Minutes from the Fed’s latest monetary-policy meeting, released last week, showed officials believed they could be close to ending their recent series of rate increases, bolstering dovish sentiment further.
“I trust this rally,” said Paresh Upadhyaya, a portfolio manager at Amundi Pioneer Asset Management.
Expectations that the Fed is slowing its pace of rate increases are making investors more comfortable holding high-yielding emerging-market assets, Mr. Upadhyaya said. He owns the Argentine peso and the country’s local-currency bonds, which he believes will benefit from fiscal improvements Argentina made since signing a bailout package from the International Monetary Fund last year. He also owns the Indian rupee, betting that last year’s drop in oil prices will help the economy of India, an importer of crude.
Another important consideration for investors is a U.S. dollar that many believe is due to weaken after a strong 2018. Valuation metrics compiled by TD Securities showed the dollar is between 4% and 19% overvalued against other major currencies. Bets on a stronger dollar in futures markets stood near their highest level since 2015 in mid-December, the latest period for which data are available, suggesting that the dollar is at risk for a sharp reversal if investors’ views on the currency turn unfavorable.
A key theme in early 2019 will be investors “dumping the expensive [dollar] in search for cheap currencies outside the U.S.,” analysts at TD Securities said.
Much can go wrong for emerging markets this year, analysts said. Unnerved investors can pull back from risky assets and head for popular havens such as gold or Treasurys if U.S. stocks grow too volatile. Evidence that global growth is declining more than anticipated can also sour appetite for emerging markets and push investors back into U.S. assets, analysts said.
Still, many are betting that emerging markets left the bulk of their problems behind in 2018. OppenheimerFunds recently raised its allocation to emerging-market equities to “overweight,” betting that a fresh round of Chinese economic stimulus and signs of progress in the trade dispute between Washington and Beijing will stoke investors’ appetite for the beaten-down assets of developing countries.
“Emerging-market asset valuations remain the most attractive globally, though a catalyst is necessary for current circumstances to change,” the firm said in its 2019 outlook. “A trade agreement coupled with lowered U.S. growth expectations could be the catalyst.”