Emerging markets gaining favour among investors

AS the US stock markets are in a frothy mood, with the Dow Jones Industrial Average and the S&P 500 just off their new highs, one may think that the attention of fund managers and investment money is on the world’s largest economy.

That is, however, not the case, as emerging markets (EM) too have found favour among investors, with many markets and currencies enjoying buoyancy in recent months.

Closer to home, stocks on Bursa Malaysia too have been recommended by big institutional houses, as opinion over the prospects for Malaysian equities turn positive.

In a CNBC report recently, Morgan Stanley initiated Malaysia’s stock market at “overweight”. It feels the upcoming general election will be a boost to the market and the increased spending on infrastructure will lift sentiment.

Private investments funded by China as part of the “One Belt, One Road” initiative will drive investments, as in 2016, China and Hong Kong made up 40% of Malaysia’s foreign direct investment. Malaysian corporate earnings are also poised for recovery, Morgan Stanley says, estimating that profit growth would improve 8% to 9% in 2017-2018 after three years of decline.

But it is not just Morgan Stanley that is now bullish on Malaysia.

Some weeks back, Credit Suisse gave its reasons on why it was time to buy into Malaysia and the FBM KLCI has been up 0.62% since then.

During the first quarter, EM around the world saw positive activity in their stock markets and currencies.

According to global financial advisory Stout Risius Ross, EM economies with large foreign exchange reserves, low dollar-denominated debt, strong current account balances and solid public finances are likely to manage the aftershocks of a US Federal Reserve rate hike more effectively.

Argentina emerged as the best EM performer for the first quarter of the year, with its Argentina Merval Index registering a 19.8% gain, according to Bloomberg data.

This was followed by India’s Nifty 50 Index and the Philippines’ PSEi, which saw a 12.07% and 6.89% growth, respectively.

For Argentina, Morgan Stanley Research opines that the nation’s fiscal consolidation remains in focus, given elevated inflation and the necessity to re-establish policy credibility, following its recent return to the international capital markets.

Apart from that, the Nifty 50 Index performance shows that investors are confident about the India’s reform agenda.

During the annual central government budget announcement in February, the India has targeted to cut fiscal deficit to 3.2% of gross domestic product (GDP) for the fiscal year ending March 2018 (FY18), as compared to 3.5% in FY17.

In addition, legislation related to the country’s goods and services tax continues to progress.

Meanwhile, Morgan Stanley Research expects EM, excluding China (EMXC), to be the key driver of acceleration in global growth in 2017 and 2018.

This is supported by continuous improvements in the macro-stability indicators of EM, with concurrent rallies in external and domestic demand.

Since November 2016, EM high-frequency indicators such as exports, the composite purchasing managers index, industrial production and capital imports have risen, indicating a revival in EM growth momentum.

“While most EMXC have already made a significant correction to macro policies, driving a major improvement in their macro-stability indicators, they still need to stay on the path of gradual implementation of the three key policy reforms – fiscal consolidation, public infrastructure spending and management of financial stability risks.

“In our base-case forecasts, we are building in gradual progress in the right direction in each of those policy areas, and we view the risks to the growth outlook as balanced,” says Morgan Stanley in a report.

The research house expects EMXC to achieve an average GDP growth of 4% over 2017 and 2018, compared with the consensus forecast of 3.9%, noting that it will be the first meaningful acceleration in EMXC since 2010.

Franklin Templeton Investments executive chairman Mark Mobius also notes that EM currencies generally gained against the US dollar over the quarter, as waning confidence in the ability of the US government to stimulate growth or impose trade sanctions led investors to adopt a weaker view on the US dollar.

The Mexican peso, Russian ruble and South Korean won were among the top-performing currencies.

“The uncertainties of the new US administration have led to lower valuations in Mexico, providing long-term investors an attractive entry point.

“In our view, the valuations of both Mexico’s currency and stocks are compelling, as country risk is falling and unemployment remains at decade lows,” adds Mobius.

In another note, Schroders Investment Management co-head of EM Debt Relative James Barrineau says EM inflation is falling towards developed levels, even as EM growth stabilises at twice the growth rate of developed market (DM) economies.

“That is making real interest rates attractive, especially relative to DM, and is drawing capital.

“This leads to appreciation in EM currencies and allowing their central banks to cut interest rates.

“Furthermore, forex reserves are rising, serving as a building block to improving credit quality,” adds Barrineau.

Real interest rates on a comparative basis will continue to be attractive in EM, via a noticeable currency appreciation cycle.

Hence, the overall credit quality of EM compared with DM should continue to improve.

“So, even if dollar debt spreads began the year at historically rich levels relative to DM, relative improvement in EM credit quality suggests that more tightening can happen, and local currency returns could be extremely generous in selected countries,” says Barrineau.