Emerging market assets are bouncing back after years of underperformance, but we think selectivity is still key to EM investing. Here are some of the long-term opportunities we are looking at.
Investors mostly saw Brexit as a negative for markets, but many risk assets have rebounded from the selloffs immediately after the referendum vote in late June. Somewhat surprisingly, after years of lethargy, emerging market (EM) assets have performed strongly since. We see opportunities here, especially in equities of Mexico and India as well as EM bonds, and more potential upside.
EM equities are up 3.0% while developed market (DM) equities have been flat, and EM bonds have gained 3.3%, according to Bloomberg data. What happened? Looking back, the EM environment started turning earlier in the year. As shown in the chart below, signs of economic stabilization in China combined with recovering commodity prices and a weaker U.S. dollar created short-term tailwinds for EM assets. The U.K. referendum, while adding volatility, reinforced some of these trends, most notably driving expectations that the U.S. Federal Reserve (Fed) would keep interest rates low for longer. And investors have been looking for ways to distance themselves from DM-driven volatility. As EM valuations remain attractive, we see more possible upside.
Close ties to a growing U.S. helps Mexico
We remain neutral overall toward emerging markets, but look for specific longer-term opportunities. Take Mexico, for example. It is closely connected to the United States, which is still one of the strongest performing DM economies and whose manufacturing data has remained in expansion this year, according to Bloomberg data. The U.S. dollar weakness, which we expect could continue, is a positive. The stabilization in oil prices (despite some selling after the vote) has also been a tailwind, given Mexico's major exports are crude oil and vehicles. And let's not forget, the country has been making some progress with reforms. Taken together, our long-term outlook for Mexican assets is positive.
Better inflation and current account trends for India
India is another emerging market that we find attractive for long-term investors. The country has been one of the growth bright spots in emerging markets; a recovery that we believe is broadening and reaching many parts of the economy. In addition to benefiting from some of the same forces that support emerging markets overall, we believe India's economy is turning the corner largely because of a two-year rout in energy prices. India imports nearly 75% of its oil (Source: Central Statistical Office, India), so sustained low crude prices improved the inflation picture and current account balance (Source: Bloomberg data). Much like Mexico, structural reforms are crucial in boosting India's productivity. We expect to see continued policy progress and a turn in the credit cycle to further support the improvement in fundamentals.
More yields from emerging market bonds
Among EM assets, we also like EM bonds, particularly those denominated in hard currency, for their balance between risk and return. As yields across the world continue to be pushed lower by highly accommodative monetary policies, international investors are fleeing low (or negative) rates offered by many DM government bonds. According to Bloomberg data, EM debt is offering yields of above 4%, and despite a strong year-to-date performance (more than 13%), we see potential for significant income with lowered spread risk, given the diminished expectations of a near-term Fed move. More importantly, EM fundamentals have shown signs of improvement in many areas, including financial conditions and external balances.
Investors interested in Mexico, India and EM bonds may want to consider iShares MSCI Mexico Capped ETF (NYSEARCA:EWW), iShares MSCI India Index ETF (BATS:INDA) and iShares J.P. Morgan USD Emerging Markets Bond ETF (NYSEARCA:EMB).
This post originally appeared on the BlackRock Blog.