INVESTING

The pivot favoring emerging markets

Russ explains why the suddenly easier central bank policies could be key for emerging markets.

During the week of June 17th, almost every asset class, from emerging market debt to bitcoin, surged. The catalyst? The same one responsible for the 10-year old bull market: easier monetary policy. This suggests that while uncharacteristically stingy central banks may have harmed risky assets last year, 2019 is shaping up to be yet another year of liquidity driven gains.

Under this scenario, assets levered to financial conditions are likely to be some of the best performers. Included among them: emerging markets (EM) stocks.

Since late February, the MSCI Emerging Market Index has been flat. In contrast, developed market equities have gained about 5%. With the recent pivot by central banks, it may be time for EM stocks to start playing catch-up.

Bang for the buck

Buying emerging markets at a time of decelerating global growth and lingering trade frictions seems ill-timed. To be sure, both the economy and trade represent real threats to the asset class, as well as the broader market.  That said, for those investors who believe that trade will simmer, not erupt, and that the global economy will continue to grow, there is one powerful argument supporting EM equities: the prospect for materially easier financial conditions.

During the past decade both investor sentiment and the broader economy have been increasingly at the mercy of central banks. But while both developed and emerging market stocks benefit from easy money, emerging markets have historically benefited more. This is particularly true in the post-crisis era.

The changing nature of this relationship is evident in the data. From 1990 until the end of the financial crisis monthly changes in financial market conditions, as measured by the Goldman Sachs Financial Conditions Index (GSFCI), explained approximately 40% of the variation in EM equity returns.

Since 2010 and the advent of quantitative easing (QE), changes in financial conditions have explained more than 75% of the variation in EM returns (see Chart 1). And while changes in financial conditions also explain a similarly large percentage of developed market returns, historically the beta for emerging markets has been greater. In other words, when financial conditions ease, emerging markets typically get a bigger boost than developed ones.

This is why last week’s announcements were particularly relevant for EM. First the European Central Bank and then the Federal Reserve gave a clear indication of a pivot towards easier money. The subsequent change in rates, the dollar, and credit spreads immediately led to an easing of financial conditions, evident by the sharp drop in the GSFCI.

In contrast to 2018, central banks are no longer talking about “normalizing policy.” Instead, there is a renewed focus on providing downside protection for the global economy. In this type of environment, it is often the riskiest assets that gain the most.

  • Cyclical tech can continue to lead
    Investing

    Cyclical tech can continue to lead

    Jan 4, 2021 | By Russ Koesterich, CFA, JD
    BlackRock Global Allocation Fund portfolio manager Russ Koesterich discusses opportunities within Tech, though the sector has recently underperformed.
    Read full article Read full article
  • Two Quiet Clues To 2021 Market Direction
    Investing

    Two Quiet Clues To 2021 Market Direction

    Jan 4, 2021 | By Rick Rieder
    Rick Rieder and team highlight two recent publications that might prove instructive for portfolios in 2021.
    Read full article Read full article
  • Investing

    Reconciling Financial Markets with the Real Economy

    Jan 4, 2021 | By Jeff Shen
    COVID has accelerated some economic trends into warp speed and our quantitative tools are telling us that these trends have a long way to run.
    Read full article Read full article
RSS

Get the latest updates from our RSS feed

Subscribe to our weekly insights email

Please try again
First Name *
Please enter a valid first name
Last Name *
Please enter a valid last name
Email id *
Please enter a valid email
Country *
This field is mandatory
 Thank you
Thank you for subscribing to BlackRock Market Insights