It’s not always who yells loudest that should be heard. In the U.S., market participants have been focused on politics of late: the goings-on in Washington, DC, the fate of health care legislation, potential timing of tax reform. In Europe, the recent Dutch election and anxiety over the vote in France have been front and center, gauges of the influence of populist forces. Obscured by this commotion, however, is that emerging markets have been quietly outpacing all other major market segments for the year to date. EM equities (as represented by the MSCI Emerging Markets Index) are up 9% in local currencies and 13% in U.S. dollars, while EM debt (as represented by the JP Morgan GBI–EM Global Diversified Composite Unhedged USD Index) has risen about 7% (local currency).
Our view on EM has been somewhat mixed. Back in November, our Asset Allocation Committee lowered its 12-month return outlook for both EM equity and debt, with post-election concerns over a shift in U.S. monetary policy, dollar strength and the possibility of increased tension on trade, given Trump campaign rhetoric. At the same time, we acknowledged the strong long-term case for emerging markets, built on improved debt positions, more stable financial systems and growth potential.
Economic Prospects Prevail, for Now
The global rally in risk assets since the U.S. elections has reflected optimism about expansive fiscal policies from the United States. Accelerating global growth has been particularly important in the emerging world. EM economies are expected to grow at their fastest pace in almost three years, driven by Brazil, Russia and China. Although oil prices have recently seen a pullback, commodity prices have generally remained stable, supporting the EM economies that rely on them for expansion.
Moreover, a couple of anticipated headwinds have been a bit less forceful than advertised. Typically when U.S. rates rise, it puts pressure on emerging markets. While the Federal Reserve is on track in raising rates, their current “Fed dots,” anticipating only two remaining increases this year, have been viewed as a dovish sign. Also, the tone of the new administration has softened to some degree on trade. However, we need to watch the politics carefully. Policies like the border adjustment tax or actual restrictions on trade would likely have a negative impact on EM currencies and growth.
Keep an Eye on Valuations
From a market perspective, there is some vulnerability to a pullback here, given recent advances. Emerging market valuations, like most risk assets, have moved higher. Despite overall price/earnings multiples that remain below those of developed markets, the growth sectors of the EM world are stretched. For the MSCI EM Index, keep in mind that lower-valued sectors like financials and basic materials tend to dominate this benchmark. On the fixed income side, EM bond yields range from 5-7%, depending on the sector, which is appealing compared to 2.4% for the 10-year U.S. Treasury or 0.4% on the 10-year German Bund.
Of course, it’s important not to overgeneralize. Emerging markets are not homogeneous. For example, export-oriented economies in Asia tend to be more exposed to global trade (for better or worse), while some other economies may be driven more by commodity prices or growing domestic demand. Perhaps the important idea here is that the most attention-getting developments are not always the most important ones. Fundamentals are fundamentals.
In Case You Missed It
- U.S. Existing Home Sales: -3.7% to SAAR of 5.48 million units in February
- U.S. New Home Sales: +6.1% to SAAR of 592,000 units in February
- U.S. Durable Goods Orders: +1.7% in February (excluding transportation, durable goods orders increased 0.38%)
What to Watch For
- Tuesday 3/28:
- Case-Shiller Home Prices Index
- U.S. Consumer Confidence
- Thursday 3/30:
- U.S. 4Q 2016 GDP (final)
- Friday 3/31:
- U.S. Personal Income & Outlays
- Eurozone Consumer Price Index
Statistics on the Current State of the Market – as of March 24, 2017
|S&P 500 Index||-1.4%||-0.7%||5.2%|
|Russell 1000 Index||-1.5%||-0.8%||5.1%|
|Russell 1000 Growth Index||-1.1%||0.2%||7.9%|
|Russell 1000 Value Index||-1.9%||-1.9%||2.4%|
|Russell 2000 Index||-2.6%||-2.2%||0.1%|
|MSCI World Index||-0.9%||0.6%||5.9%|
|MSCI EAFE Index||0.0%||2.8%||7.3%|
|MSCI Emerging Markets Index||0.4%||3.6%||12.7%|
|STOXX Europe 600||0.2%||3.7%||7.3%|
|FTSE 100 Index||-1.2%||1.2%||3.8%|
|CSI 300 Index||1.3%||1.1%||5.4%|
|Fixed Income & Currency|
|Citigroup 2-Year Treasury Index||0.2%||0.0%||0.2%|
|Citigroup 10-Year Treasury Index||0.9%||-0.2%||0.7%|
|Bloomberg Barclays Municipal Bond Index||0.6%||0.0%||1.4%|
|Bloomberg Barclays US Aggregate Bond Index||0.6%||-0.1%||0.7%|
|Bloomberg Barclays Global Aggregate Index||0.9%||0.3%||1.9%|
|S&P/LSTA U.S. Leveraged Loan 100 Index||-0.2%||-0.2%||0.6%|
|BofA Merrill Lynch U.S. High Yield Index||-0.2%||-1.1%||1.8%|
|BofA Merrill Lynch Global High Yield Index||0.1%||-0.5%||2.6%|
|JP Morgan EMBI Global Diversified Index||0.7%||0.4%||3.9%|
|JP Morgan GBI-EM Global Diversified Index||1.3%||3.3%||7.5%|
|U.S. Dollar per British Pounds||1.0%||0.4%||1.1%|
|U.S. Dollar per Euro||0.6%||1.7%||2.4%|
|U.S. Dollar per Japanese Yen||1.5%||0.8%||5.0%|
|Real & Alternative Assets|
|Alerian MLP Index||-0.3%||-3.4%||1.8%|
|FTSE EPRA/NAREIT North America Index||0.1%||-3.3%||-0.3%|
|FTSE EPRA/NAREIT Global Index||0.2%||-1.0%||3.4%|
|Bloomberg Commodity Index||-0.7%||-3.6%||-3.3%|
|Gold (NYM $/ozt) Continuous Future||1.5%||-0.4%||8.4%|
|Crude Oil (NYM $/bbl) Continuous Future||-1.7%||-11.2%||-10.7%|
Source: FactSet, Neuberger Berman.