Emerging markets rally, but investors should pick countries carefully

Is this a sign that the emerging-market rally is nearing the end? Not necessarily. While emerging markets are often more volatile than developed ones because of low volumes, fewer participants, corporate-governance problems and political instability, the differences are beginning to get blurred.

The June 23 last year Brexit vote sent shockwaves through the markets and chased investors away from the United Kingdom, while in Europe uncertainty about further monetary stimulus and political worries affected investor confidence. In the United States, the presidential campaign is raising investors’ fears.

In this volatile atmosphere in the developed world, assets in developing countries look more and more attractive. Recently, emerging-market debt funds saw their largest four-week inflows ever, worth around $14 billion.

One big factor pushing investors into developing markets is the dovish Federal Reserve. David Rees, an analyst at Capital Economics, noted that the weaker-than-expected US economic-growth data released last week have “made it unlikely that the Fed will raise interest rates next month.”

He forecasts that the MSCI Emerging Markets Index will rise by another 20% by the end of 2018, as global monetary conditions are expected to remain loose and commodity prices have bounced back from their lows.

Various PMI data released yesterday showed that a recovery is under way in the big emerging markets. Capital Economics noted that increases in PMIs occurred in the largest developing markets: China, India, and Brazil. For the latter, the improvement in the manufacturing PMI “adds to the evidence that the economy is finally starting to turn the corner,” said Liza Ermolenko, an emerging-markets economist at the think tank.

It is time for investors to differentiate among emerging markets. In July, the bulk of equities inflows went particularly to Taiwan, Korea, India, and Brazil, while Indonesia, India, and Turkey saw the largest bond inflows, according to data from Societe Generale.

One area that investors would do well to take a long, hard look at before committing more money to is Central/Eastern Europe. While it is true that companies in the area benefit from the effect of the European Central Bank’s unprecedented asset purchases (these countries export most of their goods and services to the Eurozone), they might be hit by the Brexit’s effects.

The United Kingdom’s departure from the EU could be a double whammy for Central and Eastern Europe. Countries in these regions have been among the biggest recipients of EU funds, but the money is likely to diminish as the U.K contribution disappears or dwindles, depending on the conditions that Britain negotiates. Secondly, their citizens may find it more difficult to move to the United Kingdom in search of better-paying work, and this would diminish remittances back to these countries.

Still, even this region is worth keeping an eye on for future opportunities. Individual companies could still prove attractive as their links with firms in Eurozone powerhouse Germany strengthen or if they get more outsourcing contracts from U.S. firms. Moreover, the region is likely to continue efforts to upgrade outdated infrastructure and to invest in defense.

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