The Daily Prophet: Betting Against Emerging Markets? Good Luck

Connecting the dots in global markets.

Emerging-market stocks posted their best performance in a year last week, gaining 4.45 percent as the MSCI Emerging Markets Index rose for five straight days. So, time for a breather, right? Not exactly.

The market for developing-nation stocks plowed ahead again on Monday, bringing its year-to-date gain to 21.9 percent. The rally was sparked, in part, by data showing China's economy grew a faster-than-forecast 6.9 percent in the second quarter. While some China watchers may doubt the data put out by the government, investors were clearly encouraged. But, there's a bigger story, which is that emerging-market finances are their best in years, bolstering confidence that they can withstand monetary policy tightening in developed economies. The 12-largest emerging-markets now have foreign-exchange reserves totaling $3 trillion, up from $2.92 trillion in late 2015 and the most since 2014, according to data compiled by Bloomberg.

A growing stockpile of currency reserves has left developing nations with “greater firepower” than four years ago to absorb global shocks, giving investors “greater confidence in the macro stability of an EM country or region,” said Viraj Patel, a London-based foreign-exchange strategist at ING Groep. HSBC Holdings says it is bullish on local-currency government bonds in Mexico, South Africa, India, Indonesia, Malaysia and Russia, according to Bloomberg News' Kartik Goyal and Aline Oyamada. The MSCI Emerging Markets Currency Index is up 6.96 percent this year even with two rate increases by the Federal Reserve.

When you have the most bullish call for the S&P 500 Index, there's no use trying to shrink from the spotlight. Morgan Stanley Chief Equity Strategist Michael Wilson doubled down on his call for the benchmark to reach 2,700 by year-end, saying that a second-quarter earnings season that’s set to beat the consensus and reinvigorated faith in the Trump administration’s policy objectives will spur the S&P 500 about 10 percent higher. Key to his bullish outlook: The S&P’s 12-month blended forward price-to-earnings ratio should move higher after softening since March as market confidence in the President Donald Trump’s ability to implement pro-growth measures dwindled, according to Bloomberg News' Sid Verma. A signal that health-care and tax reform is on the horizon should trigger capital spending and merger and acquisition activity that will buoy 2018 earnings and higher equity valuations, the firm says. Morgan Stanley projects that forward earnings ratios should approach 19 times over the next two quarters, from around 17.5 currently. Wilson's S&P 500 forecast compares with the median of 2,438 in a Bloomberg News survey late last month.

Hardly a day goes by without someone warning about the excesses in the market for speculative-grade, or high-yield, debt. But that hasn't stopped investors from pouring money into the securities. The latest example comes from Europe, where companies have sold 1.7 billion euros ($1.9 billion) of notes with ratings of at least seven levels below investment grade -- among the lowest available -- so far in July. That’s already the most for a full month in more than two years, according to Bloomberg News' Katie Linsell. The whole European junk bond market is on track for the busiest July on record. In a sure sign that it's a sellers market, Dutch department store operator Hema BV, home improvement retailer Maxeda DIY Holding BV and supercar maker McLaren Group are the latest in a string of companies selling bonds with weaker investor protections, known as covenants, and with more loopholes written into the documents that govern the debt. Lucror Analytics recommends investors push back against the proposed documentation for both Hema and Maxeda or demand higher relative yields at the least.

The big news in the commodities market Monday centered on lumber, where futures prices jumped by the exchange limit in Chicago to the highest in more than two months. More than 375 wildfires have swept across Canada's British Columbia, burning forests and forcing sawmills to shut down or evacuate, according to Bloomberg News' Jen Skerritt. While the impact on supplies is minimal so far, there are concerns the blazes will continue to spread amid hot, dry conditions, according to Paul Quinn, an analyst at RBC Capital Markets in Vancouver. West Fraser Timber Co. suspended operations last week at three lumber mills that represent annual production capacity of 800 million board feet of lumber and 270 million square feet of plywood. Norbord Inc., the largest North American producer of oriented strand board used in residential construction, suspended production at its mill in 100 Mile House in central B.C. Lumber futures for September delivery rose by the $10 trading limit to $387.30 per 1,000 board feet at 2:56 p.m. local time on the Chicago Mercantile Exchange.

Despite the economy's recovery from the last recession eight years ago, U.S. states are hesitant to take on added borrowings, according to Bloomberg News' Martin Z. Braun. States paid down debt for second straight year in 2016 as slow revenue growth and rising expenses for pensions and health-care restrained borrowing, S&P Global Ratings data show. The tax-supported debts of states declined 0.4 percent following a 1 percent slide in 2015, according to the firm's annual survey. The trend has buoyed the municipal-bond market by holding back the pace of new sales, even though interest rates haven’t risen too far from the more than half-century lows of a year ago. Tax-exempt bonds have returned 3.7 percent in 2017, more than twice as much as Treasuries, according to Bloomberg Barclays indexes. “The lingering budgetary stress that states are exhibiting well into the economic recovery highlights the limited resources and competing priorities states face when considering infrastructure spending levels," S&P analyst Carol Spain said.

All eyes will be on the U.K. Tuesday when the government releases its inflation data for June. The readings will get extra attention following some recent flip-flopping by Bank of England Governor Mark Carney on the need to raise interest rates. Within a span of about a week late last month, Carney went from saying this is not the time to raise rate to saying policy makers may need to begin raising them. The June data will probably show that the collapse in sterling continues to account for inflation exceeding the Bank of England’s target of 3 percent, making it unlikely the release will prompt a shift in the balance of power on the Monetary Policy Committee, according to the economists at Bloomberg Intelligence. That means the doves are set to remain in the driving seat this year, they wrote in a research note.

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