The Year of the Emerging Markets, Burned by US Treasuries, Is Back
(Bloomberg) — Across Wall Street, analysts and investors had cheered 2023 as the year of emerging markets, only to be burned by a relentless climb in US Treasury yields. Now, as the Federal Reserve looks set to end its most-aggressive monetary tightening campaign in a generation, they’re at it again.
Euphoria is already spreading through developing-nation assets, spurring a 7.9% rally in stocks and a 6.7% run-up in sovereign bonds last month. Investors are also pouring cash into the world’s largest exchange-traded fund tracking emerging debt — a signal that mom-and-pop retail traders and sophisticated risk-takers alike are once again taking on the risky asset class.
“I’m very fundamentally positive,” said Pramol Dhawan, Pacific Investment Management Co.’s head of emerging-market debt. “EM is an under-owned asset class, but when you look under the hood and you dig a little bit deeper, then this is an asset class you should want to own.”
Now, as the new year approaches, Wall Street is renewing its optimistic chorus. Goldman Sachs and Morgan Stanley are both calling for double-digit returns for developing-nation sovereign dollar bonds in 2024. Pimco, whose emerging-market local currency and bond fund has outperformed 95% of peers in the past year, still favors domestic debt.
But even as the stars seem to align for the bull case, some investors remain unconvinced that emerging markets will rally from current levels.
Uncertainty lingers around China’s growth outlook, and swings in the US Treasury market have stoked skepticism as traders try to gauge the Fed’s path ahead.
“Investors should take caution,” said Sylvia Jablonski, chief investment officer of Defiance ETFs. With US rates still far from stable, the next few months will prove crucial as the Fed solidifies its policy stance, she said. “We must see how this narrative plays out.”
To some investors, it comes down to math. At times when an investor could collect a yield of about 5% by owning a US two-year bond, “why would you buy Indonesia? Why would you buy anything else?”
The bulls, however, say there’s money to be made in emerging markets — as long as they play it right.
The high-yield segment is also enticing, with some investors favoring high-yielding bonds where markets are overly pessimistic on the risk of default and restructuring.
Morgan Stanley strategists favor dollar-denominated high-yield government bonds next year from eight countries ranging from Colombia to Egypt, as well as corporate debt from Mexican oil company Petroleos Mexicanos.
In addition to remaining bullish on local-currency debt, Pimco is eyeing nearshoring trends, which it says support assets from Hungary, Czech Republic, Poland and Mexico.
What to Watch:
– Third-quarter GDP data in Brazil
– President-elect Javier Milei’s announcements in Argentina
– The Reserve Bank of India’s December meeting
– CPI reports from South Korea, the Philippines and Thailand
– Inflation data from Turkey
–With assistance from Matthew Burgess, Michael Mackenzie, Srinivasan Sivabalan and Aline Oyamada.
(Updates with Turkey inflation data.)