The backdrop for equities in emerging markets is turning more positive as the U.S. dollar weakens and China reopens its economy after stringent COVID-19 restrictions, according to BlackRock, the world’s largest asset manager.
Stocks in emerging markets have recently rallied, after broadly lagging developed-market equities, down nearly 20% since mid-2021 when many emerging-market central banks began tightening monetary policy, BlackRock Investment Institute said Tuesday in a note led by global chief investment strategist Wei Li.
“We think the long EM stock slide and recent rally show a lot of economic damage is now in the price,” Li and other BlackRock investment strategists said in the note. Emerging-market rates are peaking, while the U.S. dollar’s retreat and China’s reopening rally have also helped emerging-market assets in recent months, they wrote.
Meanwhile, the ICE U.S. Dollar index
a gauge of the dollar’s strength against a basket of major currencies, is down around 1.1% this year, according to FactSet data, at last check.
The dollar soared in 2022 as the Federal Reserve aggressively tightened its monetary policy in an effort to tame surging inflation in the U.S. The pace of inflation, though, has been showing signs of slowing, giving investors hope the Fed might pause its interest-rate hikes in 2023.
“A pause in the Fed’s rate hikes would likely help spur a further retreat in the U.S. dollar,” according to the BlackRock note.
“EM economies proved resilient to what should have been a big hit from tightening global financial conditions as the Fed embarked on the fastest hiking cycle since the 1980s,” the strategists said.
That’s partly because central banks in emerging markets were ahead of policy tightening in developed markets, while “higher commodity prices limited the fallout,” according to their note.
Meanwhile, “the damage of higher rates has yet to fully materialize” in developed markets (DM), the strategists said. “We prefer selected EM equities and bonds over DM peers.”
The iShares MSCI Emerging Markets ETF
has jumped 8.4% this year through Tuesday, beating the S&P 500’s gain of around 4%, according to FactSet data. And shares of the iShares MSCI EAFE ETF
which tracks developed-market equities in Europe, Australia and the Far East, have climbed 7.8% over the same period.
Emerging markets generally have “higher levels of currency reserves, smaller current account deficits, improved external balances and better debt maturity mixes than they did in past DM tightening cycles that sparked volatility,” the BlackRock strategists said.
“At its peak, the U.S. dollar rose over 19 percent in 2022 before declining in the fourth quarter,” said Wade Balliet, chief investment adviser for BNP Paribas’s Bank of the West Wealth Management Group, in a note dated Jan. 11.
Many emerging markets rely on U.S. dollar-denominated borrowing to “build out” their economies, said Balliet. “When the Fed hikes interest rates, which strengthens the dollar, this makes those loans more and more expensive to pay back.”
Over the past few months, he wrote, “while U.S. stocks held stable, emerging markets rose over 20 percent and entered a bull market.”
U.S. stocks closed mostly lower Tuesday as investors weighed fourth-quarter earnings results from Goldman Sachs Group
and Morgan Stanley
The S&P 500
finished 0.2% lower, while the Dow Jones Industrial Average
dropped 1.1% and the technology-laden Nasdaq Composite
edged up 0.1%.