EM stocks poised for best quarter in 5 years

These are good times for emerging markets investors.

EM equities are poised to clock their best quarter in five years, as growth continues to rebound and the threat of a more aggressive Fed interest-rate tightening cycle eases, boosting the appeal of higher-yielding non-dollar-denominated assets.

Despite retreating 0.9 per cent on Friday, the MSCI Emerging Market stock index is on course to hand investors a 11.4 per cent gain for the first three months of the year, its strongest quarter since the start of 2012. The performance also handily beat returns from developed market bourses, with the S&P 500 up 5.6 per cent and Germany’s Dax stock index gaining 6.7 per cent over the same period.

The strong start to the year underscores a sharp reversal of sentiment among investors, with many now appearing more sanguine about the Trump administration’s abilities to deliver on its promised protectionist trade measures. With US economic growth still humming along, some think Trump’s proposed tax cuts and infrastructure spending could provide a boost to EM economies, which have been benefitting from the recent stabilisation in commodity prices.

“EM growth has continued to pick up in recent months and is now running at a three-year high,” said Neil Shearing, chief emerging markets economist at Capital Economics. “While China’s recovery seems to be running out of steam, Emerging Europe and Latin America have picked up the baton and are now driving the improvement in aggregate EM growth.”

Separately, the threat of a more aggressive Fed has also dissipated somewhat after the US central bank signalled this month that it was in no hurry to raise rates.

The prospect of higher US interest rates tend to rattle EM assets – in part by driving up the greenback and raising the costs for countries with a lot of dollar-denominated debt, and by drawing investors’ cash back into US assets at the expense of developing markets.

The Fed’s cautious approach of sticking to its previous forecast for three rate rises this year is reassuring, while weakness in the dollar has renewed appetite for higher-yielding EM assets. Aside from stocks, EM currencies have shone as well this quarter. The JPMorgan Emerging Markets Currency Index is set to end the first three months of this year 3.4 per cent higher, its best performance in a year.

For return-seeking investors, the relatively low valuations of EM stocks have been another selling point.

“The forward price/earnings ratio of EM equities is far lower than that of the US stock market, which is now around its highest level since the dot com collapse,” noted Capital Economics. “It is also lower than that of developed markets outside the US, although the difference is less striking.”