MARKET INSIGHTS

Weekly market commentary

Feb 12, 2024
  • BlackRock Investment Institute

Staying selective in emerging markets

­Market take

Weekly video_20240212

Axel Christensen

Opening frame: What’s driving markets? Market take

Camera frame

We like emerging markets as upbeat risk appetite carries on. 

Title slide: Staying selective in emerging markets (EM)

We see broader support for emerging market assets as markets price in a rosy macro outlook and fears of recession have faded.

But selectivity is key.

1: Broader support for EM

As markets have priced in rate cuts, 10-year Treasury yields have slid, narrowing the gap between them and hard currency emerging market debt yields. But spreads remain near the long-term average.

We like hard currency emerging market debt because it includes countries with higher quality credit ratings and is often cushioned from any local currency weakness.

2: Staying selective

Emerging market stocks underperformed developed market peers last year and that trend persists. China’s elevated equity volatility and policy uncertainty prompts us to take above-benchmark risk elsewhere.

3: Country-specific opportunities via mega forces

We find country-specific opportunities via the mega forces, or big structural shifts, we track like geopolitical fragmentation and demographic divergence.

For example, Mexico is increasingly acting as an intermediate trading partner between competing blocs. And India’s young, growing population stands out.

Outro: Here’s our Market take

We stay overweight emerging market hard currency debt and neutral overall on stocks, but overweight Mexico and India equities.

In our view, structural shifts favor areas like infrastructure and real estate in multi-aligned countries like Mexico.

Closing frame: Read details:

www.blackrock.com/weekly-commentary.

Emerging market appeal

We like emerging markets as upbeat risk appetite carries on. We also see big structural shifts creating granular opportunities within countries.

Market backdrop

U.S. stocks hit another all-time high last week thanks to earnings beats, even as U.S.10-year yields ticked up. We think positive sentiment can persist for now.

Week ahead

This week’s U.S. inflation data should show if falling goods prices are still pushing inflation down. We think wage growth will reignite inflation after 2024.

We see broader support for emerging markets (EMs) given the market’s upbeat sentiment on risk assets as U.S. growth holds up, inflation cools and the Federal Reserve prepares to cut policy rates. EMs have been resilient to the latest Fed rate hikes. We get granular through mega forces – big structural shifts we see driving returns. We’re overweight EM hard currency debt on its relative attraction and quality, plus stocks in Mexico and India that are set to benefit from mega forces.

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Better priced
EM hard currency debt and U.S. high yield spreads vs. average, 2015-2024

The charts shows that hard currency EM debt spread has tightened since 2023. But spreads remain near the long-term average. The yellow line shows U.S. high yield credit spreads are well below the long-term average.

Source: BlackRock Investment Institute, with data from LSEG Datastream, JP Morgan, Bloomberg, February 2024. Notes: The orange line shows the spread for EM hard currency debt, using the JPM EMBI Global Diversified Index and based off U.S. Treasuries of similar maturity and adjusted for any credit enhancements. The yellow line shows the Bloomberg US Corporate High Yield Index, an option-adjusted spread. We look at the spreads relative to their 2000-2024 average.

We think the outlook for broad EM assets is supportive as market sentiment stays positive. Robust U.S. economic activity, nearing Fed rate cuts and falling inflation have lessened the market’s recession worries – a boon for EM. As markets priced in sharp Fed rate cuts, 10-year Treasury yields slid from 16-year highs near 5%. That helped tighten the gap between Treasury yields and higher hard currency EM debt yields. But spreads remain near the long-term average (orange line in the chart). U.S. high yield credit spreads are well below the long-term average (yellow line) – a sign of expensive valuations. We prefer EM hard currency debt and stay overweight. Along with attractive relative value, it includes more countries with higher-quality credit ratings than riskier high yield. Often issued in U.S. dollars, hard currency EM debt is also cushioned from EM currency weakness as EM central banks cut rates.

While we see broad support for EM assets ahead, selectivity is key because of the divergent performance across EMs. Overall EM stocks underperformed DM peers last year and that trend has persisted into the new year. China’s elevated equity volatility and policy uncertainty prompt us to take above-benchmark risk elsewhere. China’s share of the MSCI Emerging Markets index has edged down while the weight of countries like India has climbed, according to LSEG data. As we stay nimble with our views, we identify country-specific opportunities through the mega forces we track.

The mega force lens

Geopolitical fragmentation is one of five mega forces we see playing out now as competing geopolitical and economic blocs harden. Multi-aligned or “connector” countries like Mexico are increasingly acting as intermediate trading partners between blocs. The U.S. imported more goods from Mexico than China last year for the first time since the early 2000s, U.S. data show.

Demographic divergence is another mega force we track. Many EMs benefit from young, growing populations compared with aging populations in the U.S. and Europe. That’s one reason India – the world’s fastest-growing economy – stands out. India’s talent pool, start-up ecosystem and software firms with a global footprint also make it an up-and-coming hub for artificial intelligence (AI) software, in our view. Digital disruption and AI is a mega force we see being a key driver of corporate earnings. We think these drivers support the momentum of Indian stocks even as 12-month ahead valuations – while below their post-Covid peaks – are near their highest levels of the past 20 years. By contrast, those in Mexico are closer to the 20-year average.

These shifts from mega forces favor investment areas like infrastructure, in our view. For example, investment in EMs related to the low-carbon transition – a mega force – will likely be lower than in developed markets due to a higher cost of capital. We think closing the financing gap offers opportunities but will require public sector reforms and private sector innovation.

Our bottom line

We see upbeat market sentiment boosting EM assets and stay overweight EM hard currency debt on still-attractive yields. We’re neutral EM stocks overall. Within that stance, we are selective and overweight Mexico and India stocks. But we are monitoring a slew of elections in key EM countries this year, including in India, Indonesia and Mexico.

Market backdrop

U.S. stocks booked another week of gains, with the S&P 500 hitting a new all-time high as earnings beats have boosted sentiment and offset higher yields. U.S. 10-year yields climbed near 4.20%, up about 25 basis points from the start of the year. We think positive risk sentiment can run for a while as markets price in robust U.S. growth, cooling inflation and Fed rate cuts. Yet we think still-elevated wage growth will push inflation back up beyond this year, preventing the Fed from cutting rates as much as markets expect. We think resurgent inflation will eventually become clearer and challenge sentiment.

We’re monitoring U.S. inflation data this week to gauge if falling goods prices will keep pushing inflation lower in 2024 as pandemic mismatches unwind. We think ongoing wage pressures in a tight U.S. labor market will put inflation on a rollercoaster beyond 2024. That’s why the Fed won’t be able to cut rates as much as the market still expects, in our view. In Europe, we look to GDP data for further signs of a divergence in growth among countries.

Week ahead

The chart shows that U.S. equities are the best performing asset year-to-date among a selected group of assets, while EM equities are the worst.

Past performance is not a reliable indicator of current or future results. Indexes are unmanaged and do not account for fees. It is not possible to invest directly in an index. Sources: BlackRock Investment Institute, with data from LSEG Datastream as of Feb. 8, 2024. Notes: The two ends of the bars show the lowest and highest returns at any point year to date, and the dots represent current year-to-date returns. Emerging market (EM), high yield and global corporate investment grade (IG) returns are denominated in U.S. dollars, and the rest in local currencies. Indexes or prices used are: spot Brent crude, ICE U.S. Dollar Index (DXY), spot gold, MSCI Emerging Markets Index, MSCI Europe Index, LSEG Datastream 10-year benchmark government bond index (U.S., Germany and Italy), Bank of America Merrill Lynch Global High Yield Index, J.P. Morgan EMBI Index, Bank of America Merrill Lynch Global Broad Corporate Index and MSCI USA Index.

Feb. 13

U.S., India CPI data

Feb. 14

Euro area GDP data; UK CPI

Feb. 15

U.S. Philly Fed index; Japan, UK GDP data

Read our past weekly market commentaries here.

Big calls

Our highest conviction views on tactical (6-12 month) and strategic (long-term) horizons, February 2024

  Reasons
Tactical  
U.S. equities Our macro view has us neutral at the benchmark level. But the AI theme and its potential to generate alpha – or above-benchmark returns – push us to be overweight overall.
Income in fixed income The income cushion bonds provide has increased across the board in a higher rate environment. We like short-term bonds and are now neutral long-term U.S. Treasuries as we see two-way risks ahead.
Geographic granularity We favor getting granular by geography and like Japan equities in DM. Within EM, we like India and Mexico as beneficiaries of mega forces even as relative valuations appear rich.
Strategic  
Private credit We think private credit is going to earn lending share as banks retreat – and at attractive returns relative to credit risk.
Inflation-linked bonds We see inflation staying closer to 3% in the new regime than policy targets, making this one of our strongest views on a strategic horizon.
Short- and medium-term bonds We overall prefer short-term bonds over the long term. That’s due to more uncertain and volatile inflation, heightened bond market volatility and weaker investor demand.

Note: Views are from a U.S. dollar perspective, February 2024. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast of future events or a guarantee of future results. This information should not be relied upon by the reader as research or investment advice regarding any particular funds, strategy or security. 

Tactical granular views

Six to 12-month tactical views on selected assets vs. broad global asset classes by level of conviction, February 2024

Legend Granular

Our approach is to first determine asset allocations based on our macro outlook – and what’s in the price. The table below reflects this. It leaves aside the opportunity for alpha, or the potential to generate above-benchmark returns. The new regime is not conducive to static exposures to broad asset classes, in our view, but it is creating more space for alpha. For example, the alpha opportunity in highly efficient DM equities markets historically has been low. That’s no longer the case, we think, thanks to greater volatility, macro uncertainty and dispersion of returns. The new regime puts a premium on insights and skill, in our view.

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index. Note: Views are from a U.S. dollar perspective. This material represents an assessment of the market environment at a specific time and is not intended to be a forecast or guarantee of future results. This information should not be relied upon as investment advice regarding any particular fund, strategy or security.

Read our past weekly market commentaries here.

Meet the Authors

Wei Li
Global Chief Investment Strategist – BlackRock Investment Institute
Axel Christensen
Chief Investment Strategist for Latin America — BlackRock Investment Institute
Ben Powell
Chief Investment Strategist for APAC — BlackRock Investment Institute
Beata Harasim
Senior Investment Strategist — BlackRock Investment Institute

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