Brexit Proves a Blessing for Emerging Markets as Rich Peers Wilt

  • Stocks beat developed-market peers by most since 2009
  • Plunge in volatility lures investors with safer returns

Brexit is turning out to be just what emerging-market investors have been waiting for.

The U.K. vote to leave the European Union has boosted bets central banks will keep flooding the global financial system with cash to ward off an economic slowdown, giving investors confidence to plow money back into riskier assets. Stocks in the developing world are beating advanced-nation peers by the most since 2009 this year, bonds are offering some of the safest returns worldwide and currencies posted their biggest first-half gains since 2011.

“Emerging-market people have been hunkering down, waiting for this turn for ages,” said Tim Love, a money manager at the U.K. unit of GAM Holding AG, which oversees $118 billion. “It’s feast or famine in this asset class and I think you’re about to turn the corner,” said Love, who favors shares in China, Russia and Brazil.

The revival in emerging-market assets comes after a three-year lag in performance underpinned by political crises from Russia to Brazil and slowing growth in China. Now, expectations for a weaker dollar and a disruption in trade because of Brexit are turning the tables on advanced nations. Volatility in emerging equities and currencies is now lower than developed-market peers, luring investors with better returns at lower risks.

The first full week after the June 23 British referendum proved to be the best in four months for stocks and in three months for currencies, prompting Love to say “the rally has legs both on a relative basis and on an absolute basis.” Analysts are the most optimistic on equities than they’ve been any time this year, projecting a 17 percent increase in the next 12 months.

Investors agree. As of June 27, they paid the most since October 2014 to own emerging-market stocks rather than developed-nation equities. The valuation discount fell to 23 percent, compared with an average 27 percent in the past three years.

The MSCI Emerging Markets Index has advanced 5.7 percent in 2016, compared with a 0.4 percent loss in the MSCI World Index of advanced-nation shares. That gap is the biggest since a 30 percent outperformance by developing-nation equities in 2009 when the global bull-market rally began on the back of unprecedented Fed stimulus.

“Emerging markets will continue to outperform, so long as China doesn’t have a big scare,” said Nathan Griffiths, who helps oversee about $1.1 billion as a senior money manager at NN Investment Partners in The Hague. “The outlook for their growth isn’t great, but it’s now better than developed-market growth.” Griffiths favors Indian stocks.

Currencies are recovering from the turbulence of 2015, when China devalued its currency and the Fed raised rates for the first time in almost a decade. So far, this year’s 4.4 percent gain in the MSCI Emerging Markets Currency Index is second only to the 5.2 percent advance in 2011. The JPMorgan Volatility Index slid more than 10 percent in 2016 after increasing for three successive years.

“Valuations matter,” said Aurelija Augulyte, a strategist at Nordea Markets who favors the Mexican peso and South African rand. “Many emerging-market currencies got too far away from their fair values. The economies have started to stabilize. Plus, Brexit now has helped.”

Corporate bonds in the developing world denominated in dollars provided the best mix of risk and reward compared with any global asset in the first half, Bloomberg Riskless Returns data show. While a dash for haven assets after the referendum initially pushed developed-market sovereign bonds to the top, emerging markets continue to rank high in volatility-adjusted performance.

The stand-out performers in the first half were Latin America and Russia. U.S. exchange-traded funds investing in Argentina and Peru were the best performers in the second quarter, and the Brazil fund topped the table in June. The ruble’s 15 percent rally on the back of a rebound in oil marked the best first half for the Russian currency since at least 2004.

“The first shock of Brexit is over,” said Luca Paolini, chief strategist at Pictet Asset Management in London. “Emerging markets are now looking good.”

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