Safety first in emerging markets
2) Moreover, the fundamentals of emerging economies continue to improve.
After the 2013 “taper tantrum” and commodity bust from 2014 onward, many EMs saw their external position sharply worsen and so the adjustment period required a contraction in domestic demand. That process seems to have run its course. The export cycle looks to have bottomed out and PMIs in many economies are again rising. As such, the conditions are ripe for growth in emerging economies to rise at a faster pace than in developed economies—an essential condition for a sustainable period of EM equity outperformance to restart. Such improving fundamentals are leading to (local-currency) upgrades in company earnings forecasts.
3) Any US bond market sell-off will likely be contained.
The recent uptick in longer-term US yields can largely be explained by the oil-driven rise in inflation break-even levels. Yet, for a variety of reasons, which tend to produce rare agreement among Gavekal partners and analysts, oil prices are unlikely to rise much above US$50 a barrel. Therefore, any rise in treasury yields, with an associated curve steepening (say 10-year yields at 2-2.5%), should be seen merely as a “reset” which lowers expectations about future returns from yield-chasing, without fully changing the environment.
While these three factors should, in theory, be conducive to solid EM equity performance, my preference remains for EM bonds. Changes in market phases can be violent and EM bonds offer a better sanctuary should investors be processing an end to the latest liquidity-driven party.