Stage set for emerging markets rebound

The 'brewing crisis' in emerging markets (EM) has abated as a number of economies have begun to close in on their current account deficits thereby paving the way for recovery, says BlackRock Investment Institute (BII).

In its half-yearly outlook, the research arm of BlackRock Asset Managers claimed that the biggest global change during the last six months was the stabilisation of EM following a wave of sell-offs in May 2013 and January 2014.

Year-to-date the MSCI Emerging Market index has returned 6.14 per cent, just 0.04 per cent less than the MSCI World and 3.7 per cent more than the FTSE All Share indices. This compares to a loss of 4.41 per cent in emerging markets during 2013 as developed markets rose over 20 per cent.

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fragile five

According to BII, the main driver behind this stabilisation in EM is the reduction of current account deficits in the region, particularly within the so-called 'Fragile Five' (Brazil, India, Indonesia, South Africa and Turkey).

'EM growth and markets have been weak in recent years, setting the stage for a cyclical rebound. The currencies of the "Fragile Five" declined sharply as the market punished countries with large external deficits, but there are signs this bitter medicine is making them more competitive again.

'Current account balances are forecast to recover, however divergence among EM countries is our main theme, and we favour countries with strong balance sheets that are implementing reforms to make their economies more competitive such as Mexico,' says BII.

Despite this stance on reform the BII is bearish on China, stating that as growth in gross domestic product (GDP) edges lower the Chinese government may be forced to delay the market reforms they have promised, especially if export growth - which makes up a quarter of China's GDP - stalls.

Another factor behind the success of EM this year is the persistent low global interest rate environment, which the BII claims has rewarded excessive risk taking in equities. However, the institute voiced concerns that rising equity valuations were not in line with earnings growth.

'The longer low interest rates last, the more stretched valuations become and equity markets are at risk of becoming disconnected from earnings growth. Multiple expansion (investors paying a higher price for the same level of earnings) drove gains in almost all major markets last year,' says BII.

However, the institute claims that global equities are not yet in 'bubble territory', although it does add that a rise in global leverage (borrowing) would be a worrying signal.

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