The two-year rally across emerging-market assets is just the beginning, according to some of the world’s largest investors.
Money managers at shops from Franklin Templeton to BlackRock Inc. are betting that developing-nation stocks and bonds will continue to appreciate in the months and years ahead as they catch up from more than half-a-decade of underperforming U.S. assets.
The bullish calls come amid lofty asset prices globally and growing concern that they aren’t sustainable, especially as U.S. central bankers pare the stimulus that helped fuel gains. Even in this context, emerging markets will benefit from stable commodity prices, improving economic growth and balance-sheet repairs since a bout of interest-rate anxiety in mid-2013 spurred a selloff known as the taper tantrum, according to Michael Gomez, who oversees $40 billion in emerging-market debt at Pacific Investment Management Co.
“We still think EM screens fair-to-cheap,” Gomez said from Newport Beach, California, where he manages a local-currency bond fund that’s outperformed 72 percent of peers in the past year. Any dip in prices “could be a relatively short-lived affair and we have the dry powder to take advantage of it.”
Investors have been timid in returning to emerging markets since the taper tantrum, but that’s changing. Funds investing in developing-nation debt added $1.3 billion in the week ending Sept. 21, posting inflows in 34 of the past 35 weeks, according to EPFR Global. Stock flows also increased.
Another sign that emerging-market equities still have plenty of room for gains is that the amount of money portfolio managers dedicate to the space is still below levels seen before the 2008 financial crisis, according to Stephen Dover, who oversees $416 billion at Franklin Templeton. He’s overweight Brazilian and Argentine stocks on optimism that their political reforms can continue as well as Vietnamese and Indonesian equities on strong growth forecasts.
“The stock market is at an all-time high, but that’s because there’s no alternative,” Dover, Templeton’s head of equities and chief investment officer of its emerging-market arm, said from Ho Chi Minh City. “The U.S. has been such a disproportionate outperformer these past few years that there has to be some equilibrium. On a relative basis, emerging markets will likely outperform the U.S. over three to five years.”
Developing-nation stocks have jumped 28 percent this year, poised for the best annual gain since 2009, as they approach all-time highs. Sovereign dollar bonds have rallied 8.8 percent and hit record levels this month compared to an average 7.1 percent return for developed-nation notes, according to data compiled by Bloomberg. Emerging-market currencies have climbed to their highest level against the U.S. dollar since October 2014.
Still, there could be some near-term speed bumps. On Sept. 20, the Federal Reserve said it will begin winding down its balance sheet in October, effectively dialing back on the easy money that has helped fuel the lofty valuations in assets around the world.
Wall Street’s response to the Fed’s tapering plan has so far been muted as a weaker dollar spurs optimism about developing-world assets. Current-account deficits -- the broad trade measure that spurred concern in 2013 -- are less than half their size four years ago in countries including South Africa and Turkey.
Other risks include the outlook for Chinese politics and a heavy electoral calendar next year from Mexico to Venezuela, according to Gomez, who favors Brazilian local rates and Argentine debt. He sees potential leadership changes helping drive higher growth over the next decade in nations that have muddled through sluggish expansions or recessions.
"It’s been somewhat of a joyless rally so far," Gerardo Rodriguez, a former deputy finance minister in Mexico who’s now a money manager at BlackRock, said from New York. "For emerging-market equities, the rally can go well into 2018 or beyond."
He favors equities in Brazil, China and Indonesia and debt from higher quality credits such as Poland and Mexico.
Leon Eidelman, who oversees about $90 billion for JPMorgan Investment Management Inc., said he’s adding exposure to “new economy” stocks in Asia. He favors technology companies including Tencent Holdings Ltd., Alibaba Group Holding Ltd. and JD.com Inc. as well as Taiwan Semiconductor Manufacturing Co. on the view that silicone production becomes more important as self-driving cars and household devices connected to the Internet gain popularity.
"We’re still confident that EM is in a much better place than it was before," Eidelman said from New York. "Are commodities going to get worse? Probably not. The dollar we’ve seen as relatively overpriced. Then you’ve got underlying economic and EPS growth that we haven’t seen in six years."