Hints of expansion, rising private-sector confidence, and weakening dollar paint sunny outlook for emerging market assets
Amid the ongoing impact of the COVID-19 pandemic clouds the global economic and investment outlook, countries around the world are maintaining an accommodative stance with continuing fiscal support and historically low interest rates. Swimming in liquidity and faced with low yields, investors are increasingly encouraged to seek out areas of growth – and right now, they may best find it in emerging markets.
In a recent commentary, Pramol Dhawan, head of Emerging Markets Portfolio Development and Vinicious Silva, portfolio manager, Emerging Markets at Pimco said signs of accelerating growth, coupled with ultra-loose monetary and fiscal policies along with attractive relative valuations, create conditions for a prolonged period of support for EM investments.
“The global manufacturing PMI – a good proxy for economic activity – has moved above its historical average, and rising prices in commodities and other cyclically sensitive assets have manifested,” the two said, arguing that the dim outlook for COVID-19 recovery in 2021 suggests many countries will keep up their massive monetary and fiscal stimulus measures for an extended time.
The current levels of global manufacturing PMI, they added, have historically come with a weakening of the broad traded-weighted dollar 77% of the time, which move the needle toward boosted EM returns.
“The U.S. dollar is coming from a period of significant outperformance,” they said, adding that above-trend broadening global growth, ongoing vaccine rollouts, and the Federal Reserve’s extremely accommodative position point to a depreciation in the greenback in line with its typical post-U.S. recession behaviour. “The prospects for additional fiscal stimulus with a new Democratic Senate majority likely will accelerate this trend.”
And while country-specific issues could once again take centre stage later in 2021, Dhawan and Silva argued that demand for EM assets should get a lift from global drivers of growth. In particular, they pointed to an unleashing of pent-up demand in global economic sectors that have been heavily impacted by mobility restrictions, as vaccination campaigns deliver a much-needed shot in the arm to private sector confidence.
Given their baseline outlook – which faces risks from a premature tightening in Fed policy, a strengthening of the dollar, slower-than-expected containment of the pandemic, or heavy-handed tapering of stimulus in China – the two said there’s more value in pro-cyclical growth-sensitive EM assets such as FX, equities, and rates than in EM credit.
“Flows to these parts of the EM complex have been modest if not negative in the last two years,” they said. “Yet, if history repeats itself, reversals in capital flows will be large and swift, and will more meaningfully impact areas, such as these, that have been out of favor with offshore investors.”
