Jan Dehn, head of Research at Ashmore, discusses why there is now a more balanced outlook for Emerging Markets (EM) versus developed markets.
Developed markets have benefitted tremendously from buying by their central banks over the last few years. Investors have jumped on this bandwagon too. By contrast, no central banks bought EM assets.
But this year something changed: the consensus of the past few years that said ‘buy DM assets and sell EM assets’ is now being challenged for the first time. It is not just that the Fed is preparing to raise interest rates. What has also challenged the consensus is that some DM valuations have begun to get seriously out of line with fundamentals.
The strong USD is hurting the US economy. Zero yields at the long end of European yield curves make no sense. This suggests that DM will have more volatility, less upside, and less liquidity going forward. This does not affect EM directly, but it does point to a more balanced outlook for EM versus DM going forward. Indeed, so far this year EM corporate debt has strongly outperformed DM corporates and EM USD denominated sovereign debt has also outperformed sovereign bonds in DM.
Many investors are obviously very focused on the timing and effects of US rate hikes. What do we think and how will EM react? In our view, the Fed is desperate to hike as a way of showing that progress is being made on the long path towards normalisation. But the Fed faces many challenges in hiking. Inflation is still low. Growth has been weaker than expected. The economy remains heavily indebted and productivity is very low.
But perhaps the greatest challenge is that asset prices in the US have benefitted far more from easy money than the economy, so the impact on financial markets could be severe. What this means is that if the Fed hikes at all it will hike very little, very slowly and over a long period of time.