BNP Asset Turns Bullish on EM Equity as U.S. Stocks Look ‘Fragile’

Updated on
  • EM recovery cycle has just started; positioning not stretched
  • FX, disinflation support EM bonds, but stocks ‘more resilient’

Even with a rally that’s double the gains in U.S. stocks, emerging-market equities are still attracting bulls.

BNP Paribas Asset Management adopted a strategy favoring stocks in developing nations over U.S. counterparts two weeks ago, arguing that valuation in the former are relatively cheaper, according to Guillermo Felices, the firm’s London-based senior fund manager for multi-asset solutions. U.S. stocks are “due for a correction” amid rising interest rates because the rally has been so extended, he said.

“We see the value of the U.S. as a bit fragile, so we thought as a long-term structural trade, it makes sense to be overweight emerging markets relative to the U.S.," Felices said in an interview on Nov. 10 during a visit to Hong Kong. “The U.S. is a market we’re happy to be cautious about, and in this trade we’re underweight that market relative to emerging markets."

Within emerging markets, Felices now has “significant allocations” into Asian equities, particularly in the IT sector, as it’s the industry where valuations remain cheaper than the U.S. and earnings are solid. The sector offers a “more structural and longer-term” story than most people realize, he said, while for economies like Brazil, he’s taking a more tactical approach.

“We bought the dip following a significant correction” after political scandals involving President Michel Temer broke out, and “it paid off” as he exited the trade with 13 percent profit in euro terms, Felices said.

The MSCI Emerging Markets Index advanced 29 percent so far this year, compared with a 15 percent rise in the S&P 500 Index.

EM Bonds

Emerging-market fixed-income products will also be supported as there are still “very attractive” yields, especially in countries where inflation is “falling rapidly,” such as Brazil, and Russia, Felices said.

Finding high real rates -- calculated as 10-year yields minus inflation -- in developed markets is “very difficult,” he said.

Felices is also eyeing currencies in Latin America and central and eastern European countries, which are “undervalued” relative to long-term average valuation metrics, even after rallying this year, he said.

Here are Felices’s other thoughts:

  • The Federal Reserve’s policy normalization will be gradual, the U.S. interest rates especially in the longer end of the curve will be “fairly range bound.” In this environment, “so long as it comes hand in hand with stronger growth in the U.S., EM should be doing OK”
  • Against this backdrop, within EM assets, he would rather be overweight in equities versus fixed income as stocks are “typically more resilient”
  • A big conundrum for him is why inflation hasn’t gone higher after so many years of recovery -- “to me the game changer is inflation”
  • If the inflation regime changes and the Fed raises rates, it could “potentially alter significantly high rallies in equities and markets in general,” which are elements of recession. “While this is not our base-case scenario, they are the risks we really need to think about”
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