Photographer: Dario Pignatelli/Bloomberg

Warning Signs Flash on Best Emerging-Market Stock Gain Since 2012

  • New Year optimism gives way to caution over equity outlook
  • Volatility may be too low to be good, ETF inflows stall

Emerging-market equity traders may be in for a reality check.

Rising profit forecasts and confidence that developing nations can withstand higher U.S. interest rates have sent stocks to the best start to a year since 2012. That optimism stands threatened this week after markets from Russia to Peru wilted under the pressure of oil prices below $50 a barrel.

Now, some investors are turning cautious. They say the rally could be undone by any of the risky events expected this month: oil-price fluctuations, policy announcements by U.S. President Donald Trump or a Federal Reserve hike.

“From low stock volatility to multi-year lows in bond spreads, signs are coming together to tell us to be a little cautious,” said Simon Quijano-Evans, an emerging-market strategist at Legal & General Investments Management Ltd. in London. “Given that the performance has been positive so far this year, some might want to lock in the performance.”

Short Circuit

Traders who seek to profit from market declines are targeting developing-nation stocks once again. Short positions worth $988 million were added to the iShares MSCI Emerging Markets exchange-traded fund in the six days to March 9. That sent the short interest in the fund to the highest since Jan. 17.

No Inflows

The MSCI fund hasn’t received a single penny of new deposits since Dec. 8. Some investors had been pouring money into a bigger fund, the $48 billion Vanguard FTSE Emerging Markets ETF, but that too has dried up since Feb. 15.

Losing Momentum

Bears took the upper hand in their tug-of-war with bulls, according to a technical indicator. The directional movement index shows the green line representing the momentum of gains has fallen below the red line representing the pressure for declines.

Tighter Swings

Stock prices and volatility often move in opposite directions. The MSCI gauge has risen 7.7 percent this year, compared with a 18 percent drop in a measure of expected price swings. But volatility has fallen to levels that preceded market declines in the past.

Silver Lining

While signs of caution abound, the big picture still remains bullish for most investors. Analysts are increasing earnings estimates quicker for emerging markets than for developed markets.

Considering the gains this year, “some sort of pause or pullback would be natural,” said Tony Hann, the head of equities at London-based Blackfriars Asset Management Ltd. “Fundamentals for emerging markets, especially Asia, look good in the long term. We would look to add on weakness.” Hann said he’s “more positive” on China and India.

Legal & General’s Quijano-Evans said the risks surrounding U.S. trade policy and Federal Reserve moves mean investors must take a “step-by-step” approach to stock investing this year and be prepared for quick swings either way.

“This will be a year of short-term decision making,” he said. “It will be on a weekly or monthly basis at best.”

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