Emerging markets are in a sweet spot

Investors remain lightly invested in emerging equities, despite a rally that leaves them up almost 10% year to date, writes Luca Paolini.

China’s market is policy driven and policy right now is pumping up liquidity provision and fiscal spending, boosting Chinese and emerging market stocks.

Indeed, emerging market assets are in a sweet spot. EM currencies are the cheapest they’ve been in at least two decades relative to the US dollar.

Our analysis shows that investors remain lightly invested in emerging equities, despite a rally that leaves them up almost 10% year to date.

Fundamentals for emerging economies remain sound as most countries follow prudent fiscal and monetary policies.

China’s reflationary policies should boost exports and commodities. Chinese and Russian shares are particularly attractive, while the Brazilian market is looking very expensive.

At the same time, emerging market debt is a bright spot in the fixed-income world.

Resilient economic growth, low inflation and a stable-to-weaker US dollar should combine to support both EM local currency and dollar-denominated debt in the coming months.

We are therefore upgrading EM hard currency debt to overweight, and maintaining our positive view on local currency bonds.

China stimulus

Despite the US-China trade spat triggering a slowdown in global exports and a deterioration in business sentiment, emerging economies are faring better than their developed counterparts – thanks in part to China’s monetary and fiscal stimulus.

Another pocket of value is in UK equities. The UK’s dividend yield of 4.5% is broadly the same as it was in the wake of the Lehman Brothers bankruptcy in 2008 – too attractive to ignore even as the Brexit debacle continues. A cheap pound makes British shares look even better value.

The MSCI All Country World Index is trading near the top of a range that’s held during the past year, and leaves us questioning its potential for further gains, especially as corporate earnings growth prospects weaken.

The biggest risk for US equities in particular is that the recent softening of corporate earnings expectations continues. We remain underweight on US stocks.

Elsewhere, we have decided to raise our defensive allocation by lifting utilities to overweight from neutral. We’ve also maintained our overweight positions in healthcare and consumer staples.

By contrast, we’ve reduced industrials to neutral from overweight in response to ongoing trade disputes.

In developed bond markets, we struggle to find viable investments, except for US Treasuries, in which we remain overweight.

We have reduced US investment grade bonds to underweight. Developed market credit looks unattractive to us at a time when corporate earnings growth has peaked and credit ratings are deteriorating.

We maintain our overweight stance on gold – which acts as a hedge against global economic uncertainty, geopolitical risks and a weaker US dollar - as global geopolitical risks have recently hit an all-time high.

Luca Paolini is chief strategist at Pictet Asset Management.

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