After a weak 2018, emerging market (EM) equities have returned with a bang, with a 7% return year-to-date in local currency terms. EM also started strongly last year, though things quickly turned for the worse amid an onrush of global and idiosyncratic headwinds.
But, for now at least, we don’t expect history to repeat itself given the following supportive factors:
- A less hawkish global monetary policy outlook; the Federal Reserve has shifted from “auto-pilot” in December to a more neutral “patient” stance. As emerging market central banks usually follow the Fed, this will help other central banks take a more accommodative stance. This week the Reserve Bank of India cut rates by 25 basis points.
- Trade tensions between the US and China have eased relative to last year. While markets were disappointed that a meeting between Presidents Donald Trump and Xi Jinping is not imminent, high level talks continue. China, meanwhile, has continued to use fiscal and monetary stimulus to offset the impact of the dispute on growth.
- Waning dollar strength amid a more dovish Fed has lent further support – the JP Morgan emerging market currency index is up 2.4% year-to-date.In our view, the supportive factors that have fueled the current rally are not fully priced in yet. We maintain an overweight allocation to EM equities, which remain attractively valued at a forward price-to-earnings ratio of 11.6x versus a 30-year average of 14x. We continue to monitor risks to this position, including a disappointing outcome to the US-China trade talks, for example.
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