Emerging Markets Insight

How long can the EM equity rally continue?

Oct 31, 2017

Emerging market highlights

  • Emerging Markets (EM) have outperformed US and Global equities this year by a significant margin and there are signs that this trend can continue into 2018.
  • Global financial conditions are still supportive of EM, while the asset class is benefiting by stronger fundamentals and a surge in exports and capital spending.

Market overview

The strong outperformance of EM equities this year has left many investors scratching their heads. Although the asset class has received more than $50bn in inflows so far this year, this is only a fraction of the almost $200bn outflows that EM equities experienced in 2013-2016. For the most part, investors have been hesitant to embrace the EM trade and now they wonder if the outperformance could continue after the YTD run of more than 30%.

The main driver of the rally has not necessarily been the stronger fundamentals of EM economies but the significant improvement of global economic and financial conditions. Our proprietary GPS indicators that track economic activity on a timely manner, continue to point towards sustained above trend growth and low inflation. We are experiencing the most synchronized acceleration of economic growth since the global financial crisis.

At the same time, global financial conditions remain very easy, as long term interest rates and credit markets have evolved positively. The prospects of Fed tightening have been absorbed gradually by financial markets while the weakness of the USD has also contributed to the benign environment for risky assets.

In the past few months, we have also observed that export growth in EM economies has started to pick up, on the back of a surprisingly strong economic momentum in China, ahead of the Communist Party Congress. Capex spending in advanced economies has also started to grow, supporting EM exports further.

Going forward, the positive backdrop for EM assets is likely to continue. The combination of strong fundamentals and a benign external environment makes EM equities the asset class with the highest expected return for the next five years, according to BlackRock’s capital market assumptions. Notwithstanding the recent rally, EM is likely to continue outperforming.

YTD performance of major equity markets

YTD performance of major equity markets

Source: Bloomberg. As of Sept 2017. Index level, Jan 1, 2017 = 100

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