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Growing optimism on emerging markets

22 August 2016
After a bit of a washout moment earlier this year, a distinct rise in optimism on emerging market (EM) equities has been seen. The renewed sense of optimism towards emerging market equities is something to keep an eye on if it gets too carried away, but for now a virtuous cycle is playing through.
The EM risk sentiment index (incorporating risk metrics across bonds, equities, and currencies) has calmed down after a sequence of ‘risk-off’ episodes. Notably, the EM PMI tends to do better when the EM risk sentiment index is above zero (lower risk perceptions). This is likely part of a self-reinforcing feedback loop, as better growth is consistent with lower risk pricing and lower risk pricing provides better conditions for growth. That being the case, we could be on the cusp of a virtuous cycle for emerging markets.

The flipside of this argument is that EM risk sentiment is now complacent and sentiment and positioning is now too optimistic. The difference is when we last saw similar levels of optimism on emerging markets in 2014, commodity markets were much higher (and have now had a major downside adjustment followed by stabilisation more recently), liquidity conditions were tight at that point (now easy), and cycle indicators were not particularly strong (having turned up recently after a weak patch).

My interpretation is that the relaxation of risk pricing and the optimistic sentiment is of the justified kind – coming with the support of improving fundamentals and coming after a big shakeout rather than in a range (where sentiment tends to give the better signal). Thus the rally in emerging markets seems sustainable and may even kick off a virtuous cycle. 
This blog post has been prepared to provide general information and does not constitute 'financial advice' for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.

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Gidday Warren – good question. Resurgent strength in the USD is certainly a risk for EM but I think things are a bit different from August last year the start of this year. As Callum state’s in the post, EM are looking fundamentally stronger now. Furthermore I think there is an accepted understanding that the Fed isn’t going to do anything that will upset/unsettle global economic and financial conditions (their unofficial “third mandate”). More particularly there is less concern about the gradual depreciation in the Renminbi which has now depreciated around 7% this year That’s due to the fact there is now a bit more clarity around PBoC’s intentions towards the Renminbi, especially their view that they don’t see the need for a significant depreciation. Furthermore the Chinese economy itself has stabilised more recently.
Posted by Bevan Graham 26 August 2016 06:40 a.m.
If the Fed starts moving rates again what impact will this have on EM?
Posted by Warren Suttie 24 August 2016 11:29 a.m.
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