Global Weekly Commentary: Why we like emerging market assets
Key points
Supporting factors
We see the restart, stabilizing U.S. Treasury yields and relatively cheap valuations boosting emerging market (EM) assets after a choppy start to 2021.
Market backdrop
U.S. stocks hit record highs and 10-year Treasury yields fell to the lowest level in more than a month. Major U.S. banks reported positive first-quarter earnings.
Data watch
Purchasing managers’ index (PMI) data from key developed economies this week could shed light on the state of the economic restart.
We see the economic restart and greater stability in U.S. government bond yields - as indicated by our new nominal theme - supporting emerging market assets over coming months. Their valuations appear relatively attractive in a world of low yields after a choppy start to the year. Risks to our view include potential policy tightening and sluggish vaccine rollouts in some EMs.
Chart of the week
Yields of U.S. high yield debt and EM local-currency debt, 2018-2021
Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and not subject to fees. You cannot invest directly in an index. Sources: BlackRock Investment Institute, with data from Refinitiv, April 2021. Notes: U.S. high yield debt is represented by the Bloomberg Barclays U.S. Corporate High Yield Index, and EM local-currency debt by the JPMorgan GBI-EM Global Diversified Index.
U.S. Treasury yields and the U.S. dollar are key drivers for EM assets. Treasury yields spiked earlier in the year, leading to a sharp rise in EM yields. We think the spike was justified and reflected the faster-than-expected activity restart combined with large U.S. fiscal stimulus. We see greater stability in yields and in the U.S. dollar over coming months, with our new nominal theme confirmed by the Federal Reserve’s comments and recent market moves. This should support EM local-currency debt, in our view. Its valuation appears attractive relative to other income sources such as high yield debt, as the chart above shows. Support also comes from loose global financial conditions that make it relatively easy to borrow for now, and reduced foreign ownership in this market that helps keep contagion risk in check. We also see room for EM currencies – especially from commodity exporters - to advance, as these currencies have yet to fully reflect the commodity rally. There is a large dispersion within EM fundamentals and that demands a selective approach. See our Emerging markets marker.
Some EMs face near-term challenges including a virus resurgence, slow vaccine rollouts and rising inflation that may force the hand of their central banks. Yet we expect their economic restart to likely be delayed – but not derailed. We are overall positive on broad EM and Asia ex-Japan equities in particular over the next six to 12 months, expecting these assets to be well positioned to benefit from a vaccine-led global restart. We also see the need to be selective in EM equities. The powerful economic restart is likely to support many commodities in the near term, including oil. This should benefit the assets of commodity exporters, including some EMs, as we argued last week. Copper prices have rallied since last year as a result of a supply shortage and activity restart in key consumers including China. We see structural demand for copper and certain industrial metals associated with a transition toward a low-carbon economy for years to come. This should support prices and likely benefit EM exporters of copper and other commodities, in our view.
We see China exposures as core strategic holdings that are distinct from EM exposures. There are near-term risks in China including an anti-monopoly drive that threatens large-cap Internet companies – a large component of EM benchmark indexes - that pushes us to favour more cyclical and domestically oriented exposures. And even with such risks we still favor strategic above-benchmark allocations to assets exposed to China, including Chinese equities and government bonds. The pandemic has accelerated the rewiring of globalization – with a bipolar U.S.-China world order at its center. We believe it’s key for investors to have exposures to both engines of global growth.
The bottom line: We expect our new nominal theme – a more muted response in nominal yields to higher inflation expectations - to hold as we move toward a full reopening. The U.S. dollar has strengthened so far this year, reflecting the faster-than-expected restart in the U.S. fueled by an accelerated vaccine rollout and large fiscal spending. We expect the rise in the dollar to take a pause as markets start reflecting expectations for the reopening to broaden out, easing some pressure on EM assets. We stay overweight EM and Asia ex-Japan equities, and are warming up to EM local-currency debt as a source of income. Potential risks to our views include the deteriorating creditworthiness of many EMs as a result of massive fiscal expansion last year. Policymakers in these countries may be faced with the challenge of needing to tighten policies even as their economies still operate well below potential.
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