No Emerging-Market Tantrum Rerun Say Goldman, Morgan Stanley

  • Current-account balances are stronger now than in 2013
  • Growth expectations more upbeat relative to developed peers

An end to ultra-loose monetary policy in the U.S. and Japan is less of an Achilles heel for emerging markets than it once was.

As the Federal Reserve and Bank of Japan consider reining in policy this week, Morgan Stanley named Brazil and Indonesia among its top currency picks in a note on Tuesday, while Goldman Sachs Group Inc. included India’s rupee on its list of favorites for the next 12 months. These countries were among the "fragile five" Morgan Stanley warned three years ago would suffer most as the Fed tightened because of the size of their current-account deficits.

Since then, the average shortfall for those five nations, which included South Africa and Turkey, has narrowed to 2.6 percent of economic output from 4.4 percent. That, along with growth forecast to recover faster across the developing world than in advanced countries, leaves emerging markets less susceptible to reliving the 2013 taper tantrum if central bankers in Japan and the U.S. withdraw stimulus.

A Fed hike is “going to affect them less than it did during the taper tantrum because of those fundamental improvements,” said Kamakshya Trivedi, chief emerging-market macro strategist at Goldman Sachs in London. “The main aspect I would point to is the improvement in external balances.”

Even as odds climb on the Fed pushing toward higher borrowing costs in the coming months, $20.5 billion has flowed into exchange-traded funds investing in emerging stocks and bonds over the last 16 weeks. Three years ago, then Fed Chairman Ben Bernanke’s comments about an imminent winding down of bond buying put in place after the 2009 financial crisis were followed by three years of declines for emerging-market stocks and currencies.

Another reason for the new optimism toward emerging countries is an improving growth outlook, Trivedi said. Economic expansion in developing nations will rise to 4.9 percent on average in 2017 from 3.9 percent this year as Russia and Brazil recover from recessions, according to a Bloomberg survey.

“Growth has improved relative to the low point in 2015 and relative to developed markets it also looks better,” Trivedi said.

That resurgence is starting to filter through to corporate profits, with projected earnings per share rising faster for stocks in the MSCI Emerging Markets Index than in the equivalent equity benchmark for developed European shares.

“The emerging-markets business cycle is stabilizing relative to developed markets,” said John Lomax, London-based strategist at HSBC Holdings Plc. “We see this both in the growth and in corporate earnings numbers.”

Emerging assets are unlikely to entirely escape selling pressure if the Fed or BOJ tighten policy this week.

Investors in emerging markets need to be selective when buying bonds because valuations are already "reaching cruising altitude" and higher interest rates in the U.S. may expose "lingering fragilities," BlackRock Inc. said in a note published on Tuesday. The average yield on a Bloomberg index tracking sovereign and corporate bonds in the developing world has fallen 152 basis points this year to 4.678 percent on Tuesday.

“It makes sense that we see some volatility and more defensive positioning," Goldman Sachs’s Trivedi said.

A Fed rate increase on Wednesday may initially cause "carnage" on stock and bond markets with the dollar rising against riskier emerging-market currencies before calm returns "as if nothing really happened," Standard Bank Group Ltd. analyst Steven Barrow said in a research note.

"Clearly it would ruffle some feathers in the financial markets but that might be a good thing in the long haul if it avoids the Fed waiting until it is too late to take away the punch bowl," he said.

A bout of volatility may represent a chance to buy into the improved underlying health of emerging markets at more competitive valuations, HSBC’s London-based head of emerging-market research, Murat Ulgen, wrote in a report last week. Tumbling bond prices in September have encouraged funds including Amundi Asset Management to add to their holdings.

“Any pullback in asset performance or manageable increase in global volatility should be viewed as an opportunity to add emerging-market risk,” Ulgen said.

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