There are early signs of a rotation under way, with equity benchmarks beating local-currency bonds since the beginning of July. And traders are already starting to chase the rally, with Bank of America Corp. reporting that emerging-market equities have absorbed $4.1 billion in the week to Aug. 2, adding to inflows in the previous three weeks.
It all points to evidence that local-currency bonds, which have been the standout trade in emerging markets this year, are now facing tougher competition from stocks. While investors including Bank Julius Baer & Co. and Brazil’s Legacy Capital argue that there’s still money to be made in debt markets, bigger gains will come from stocks.
The macro backdrop is also tilting in favor of developing nations. Emerging economies are expected to expand almost three percentage points quicker than advanced nations over the next three years, led by China, albeit at a slower pace, and India. Analysts have raised their forecasts for earnings in July at the fastest clip in 18 months, according to data compiled by Bloomberg.
“The main drivers for equity performance will be a benign macro environment, especially in countries like India, Indonesia and Brazil, along with strong earnings growth driven by strength in consumption and investment,” said Ashish Chugh, a money manager at Loomis Sayles in Boston.
The MSCI Emerging Markets Index rallied almost 6% last month, the best performance since January. In contrast, indexes of dollar and local-currency EM debt gained less than 2%.
Emerging-market assets saw a 5.5% spike in capital inflows in July, the biggest since November. Investors in US exchange-traded funds have poured a net $2.61 billion into emerging-market stock ETFs in the past four weeks, while allocating just $269 million to bonds.That may just be the start, because a $5.7 trillion selloff last year has left emerging-market equities under-owned by global investors by some $600 billion, according to GW&K Investment Management.