Will the Fed spoil the EM party?Contributor Gabriela Santos
U.S. equity performance has been solid this year, but 2017 looks set to be the second consecutive year that emerging market (EM) equities outperform their developed market (DM) counterparts. Year-to-date, the MSCI Emerging Markets Index is up 33% in U.S. dollars, a step above the MSCI World’s 21% return. This has left investors wondering: what could spoil this positive trend for EM?
A prime candidate that comes to mind is the Federal Reserve (Fed) given expectations for further rate hikes next year and the continuation of balance sheet wind down. Memories are still fresh from 2013’s “Taper Tantrum”, when investors first began to price in the Fed’s policy normalization, causing shockwaves across asset classes, and especially in EM.
We do not believe that 2018 will be a repeat of 2013 for three reasons. First, the Fed has made certain their actions are well communicated in advance. Second, the speed of Fed tightening is still very gradual. Third, EM fundamentals have improved as many EM countries have taken the past few years to work on their weak spots (reducing their current account deficits, improving their fiscal results and building their FX reserves).
Lastly, global growth is significantly stronger now than it was in 2013. The U.S. economy remains on solid footing, but growth in other developed markets is looking better, which helps EM by boosting their exports. This better external backdrop, combined with healthy domestic demand, has led EM growth itself to rebound. Crucially, the gap between EM and DM growth is expanding again, and should continue to do so next year. Historically, this has been very closely related to EM equity outperformance relative to DM.
As we look toward 2018, we expect international equities to continue climbing. EM remains one of our preferred regions, especially certain countries in Asia and Latin America.
The EM growth alpha continues to make a comeback
Next 12 months consensus GDP estimates, USD MSCI price indices rebased 1997=100