Record funds flow into emerging markets

Weaker US dollar and hunt for yields continue to drive money into equities

THERE is optimism in the air, at least that’s what’s making investors pour money into equities and move out of bonds, where yields have risen.

According to Bloomberg, citing a Bank of America Merrill Lynch report, investors bought US$33.2bil of equities in the week to Jan 24, further stoking a global stock rally.

Global economic growth momentum, US tax reforms and rising corporate profits are just some of the reasons why investors are bullish on stocks.

It’s really an interesting phenomenon because when a central bank raises interest rates, bond yields will rise and currencies will strengthen, making it attractive to invest in them.

For equities to still attract the sort of flows it’s attracting, they must have better returns, especially when compared to investing in high-grade, lower risk and very liquid government bonds like US Treasuries.

The US tax overhaul will boost corporate earnings.

In fact, companies over there are planning to reward their employees with higher pay while the listed ones are also looking to reward their shareholders.

The most recent data show that low unemployment, higher wages and business investments continue to drive the US economy with analysts indicating that plans to spend on infrastructure will boost growth.

The US corporate earnings season has begun and indications are that its looking good.

That is being reflected in the US equity indices.

Year-to-Jan 25, the Dow Jones Industrial Average (DJIA) is up 6.77%, the S&P 500 has risen 6.20% and the technology-heavy Nasdaq has gained 7.36%.

S&P 500 companies are expected to see earnings rise well above 10% for the last three months of 2017 while technology companies are looking at double-digit percentage growth for profit and revenue.

Investors can be forgiven for their exuberance when taking into account that profit at S&P 500 companies grew 15.5%, 10.8% and 7.1% in the first, second and third quarters respectively.

And its not just US companies, European companies are also looking at a better year ahead after earnings recovered last year.

Analysts say margins are improving while, especially for the eurozone, the economic outlook looks good.

Private consumption is driving growth, the jobless rate is declining while a tight labour market is pushing wages higher and boosting household incomes.

Emerging markets bonanza

A weaker US dollar and persistent hunt for yields continue to drive funds into emerging markets with fund investors’ emerging market exposure reaching the highest level since April 2015, says the latest report from the Institute of International Finance.

Confidence in a positive spillover effect into emerging markets from the mature markets have also been a driver of these flows as many emerging-market economies are tied into the supply-chain that ultimately feeds into the mature markets’ consumers.

Corporate earnings should improve with better demand from these consumers.

“Emerging market fund flows amounted to some US$35bil since mid-November – a rise of more than 50% compared to the previous two months. Inflows have been particularly strong in recent weeks. Over the first three weeks of the year, funds investing in emerging market bonds and equities have attracted US$8.8bil and US$11.5bil, respectively,” it says.

The flow of funds has supported emerging market equities and currencies. A Jan 24 Maybank Investment Bank Research report show that foreigners remained net buyers of Malaysian equities in the first three weeks of January, at RM2.4bil, after buying RM900mil worth of equities in December.

But its not just equities, foreigners were also net buyers of Malaysian bonds, which saw RM2.7bil in net inflows last month after RM6.7bil in net flows in November as they wrote on the momentum of ringgit strength and the widely anticipated interest rate hike by Bank Negara, which was announced on Jan 25.

Maybank’s fixed-income research team expects foreign flows to remain positive in the local bond market despite the maturity of RM2bil worth of Malaysian Government Securities (MGS) this month. The team believes that the risk of maturity-driven foreign selling in the domestic bond market is reduced, citing net foreign buying of RM6.6bil between September and October despite RM24.8bil of MGS maturing in the same period.

The yield differentials also remain attractive for bond investors, with 10-year MGS closing with a yield of 3.92% on Jan 25 compared to similar duration US Treasuries, which closed at 2.63%. The difference in yield is 129 basis points.

Technical analysts see the local bourse continuing the positive trend, with the benchmark FBM KLCI gaining 8.82 points on Jan 25 supported by bank stocks and rising another eight points to end the week at 1,853. The index is just 40 points from all-time high of 1,896 that was achieved in July 2014.

Maybank’s forex research team also expects the ringgit to strengthen against the US dollar to 3.95 by the end of this year and average 4.05 for the whole year, after ending 2017 at 4.05 and averaging at 4.30.