Emerging markets: The skies are brighter - but for how much longer?

Emerging markets: The skies are brighter - but for how much longer?

Samy Chaar, investment strategist at Lombard Odier, discusses a cautiously optimistic outlook for emerging markets.

Emerging markets have recently attracted a fair amount of attention from investors in search of better returns. Our bullish stance on the asset class reaches back to the onset of 2016, and was based on three main factors: the USD, the commodity complex and the Chinese economy.

Positive signs on all these fronts have so far supported our thesis but, with the world economy in such a fine balance, we continue to monitor developments very closely.

As regards the USD, we felt that a break of the strong multiyear uptrend – and consequent easing of global financial conditions – would be a crucial development for emerging markets as a whole. 2016 has been an encouraging year in this respect, with the increasingly clear evidence of the Fed’s limited ability to tighten policy having taken steam out of the dollar rally. Our view on the US economy, suggests that this is likely to remain the case. Fed policy is highly unlikely to take a hawkish turn in the near future.

We also stressed that a stabilisation of commodities prices, particularly energy goods, should provide crucial support to emerging markets. The rebalancing of oil markets, after a long period of supply outstripping demand, has progressed throughout the year, and the agreement on a production cut during the recent informal OPEC meeting is likely to accelerate the process, exerting some upward pressure on oil prices and helping reduce volatility.

Our expectations for an improvement in Chinese data, driven by policy loosening, have started to materialize. The signs have been evident in a variety of metrics, and market fears of a sharp renminbi devaluation have abated. Short-run stimulus can obviously not make long-run issues disappear, but if effective it can create space and time for policymakers to deal with the debt issue.

Going forward, risks are certainly not absent. Although a Trump victory in the November US presidential election is not our base case, it would have highly significant implications for emerging markets. The volatility induced by lower policy predictability would negatively affect the emerging complex as a whole. Countries such as Mexico and China, two major US trade partners, also face direct risks that barriers on trade and immigration – a prominent theme in the Trump campaign – be imposed on them.

All told, our cautious optimism on emerging markets remains in place, supported by recent developments. We are nonetheless cognizant of the risks on the horizon, which we intend to monitor closely, adjusting our positioning accordingly.