Ominous signs for emerging markets

NEW YORK • Behind the best gains for emerging markets since 2009, there are some ominous signs that the rally is about to hit a wall.

The 13 per cent surge in stocks last month was accompanied by the lowest trading volume for five years in the markets with the biggest advances and the weakest company profits for six. In the foreign-exchange market, currencies are mirroring moves in oil prices by the most since 2012, suggesting vulnerability to any renewed weakness in commodities.

It underscores the fragility of a rebound driven by US$37 billion (S$50 billion) of inflows from investors last month, more than in any month since June 2014. Bears including Barclays and UBS say it is at odds with falling exports and contracting manufacturing in developing economies, while the forces behind the rally - a dovish Federal Reserve, stability in China's economy and rises in oil prices - are unlikely to persist.

"The macro picture for emerging markets hasn't really changed much since January," said London- based emerging-market (EM) bond manager Yerlan Syzdykov from Pioneer Investment Management, whose fund beat 98 per cent of its peers over the past three years. "The economic slowdown in emerging markets will continue until 2018."

After losing a quarter of their value since 2012, EM stocks, currencies and bonds roared back. About US$1.8 trillion in market value was added to stocks in the biggest developing countries last month, the biggest jump on record going back to 2007.

The MSCI Emerging Markets Index gained 22 per cent from a seven-year low in January, twice the increase in the benchmark for stocks in advanced economies. Local-currency bonds returned 8.3 per cent last month, the most since 2009.

Some of the headwinds have waned, at least for now. Oil prices have climbed 46 per cent from a 13-year low in February.

China stepped up efforts to support growth, and expectations of interest-rate increases from the Fed have been tempered, with chairman Janet Yellen last week saying policymakers should "proceed cautiously". With the US dollar losing ground, the average yield of 6.5 per cent on EM local-currency debt started attracting bids in a world where about US$8 trillion of global government debt offer rates below zero.

"Stop being bad is actually particularly great for an asset class that was very negative," said Mr Pablo Goldberg, who helps oversee US$10 billion in EM debt at BlackRock in New York, on Bloomberg Television last week. "You start to get a little bit better floor for currencies in EM and for commodities."

Other investors are not convinced. Fewer than 24 billion shares in the companies of the MSCI's EM benchmark changed hands every day since the rebound started in late January, compared with an average of 44 billion shares during the seven similar advances over the past five years, data compiled by Bloomberg shows.

Then there's the exposure of EM currencies to the oil price. The 60-day correlation between the two reached 0.66, near the highest since 2012. A reading of 1 indicates the two move in lockstep.

In the bond market, the gap between two-year and 10-year US Treasuries, a barometer for appetite for high-yielding assets, has narrowed to the smallest since 2007. That suggests EMs are susceptible to a reversal should inflation in the US start rising, according to Citigroup's strategist Guillermo Mondino.

BLOOMBERG

A version of this article appeared in the print edition of The Straits Times on April 04, 2016, with the headline 'Ominous signs for emerging markets'. Print Edition | Subscribe