Will the Emerging Market Rally Continue?

Fidelity Global Economist Anna Stupnytska explains how emerging market equities and bonds have gained this year - and the macroeconomic threats that may derail the rally

Emma Wall 19 September, 2016 | 11:03AM
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Emma Wall: Hello and welcome to the Morningstar series, "Market Reaction." I'm Emma Wall and I'm joined today by Fidelity Economist, Anna Stupnytska, to talk about emerging markets.

Hi, Anna.

Anna Stupnytska: Hello.

Wall: So, in the news a lot at the moment is the U.K. and Brexit and investors may have missed that there actually has been a pretty positive story coming out of emerging markets in 2016, including positive data like the one we had this morning about house prices in China. So, how has this outperformance happened?

Stupnytska: Well, this year emerging markets outperformed massively in all asset classes and that was mainly due to some stabilization in China due to the fiscal stimulus unveiled at the beginning of the year, also stabilization and some rally in commodity prices obviously related to China in some respect and finally, the ultra-dovish monetary policies by the major central banks with the Bank of England embarking on a new round of quantitative easing.

Wall: And of course, investors love a positive news story. There haven't been many of those about recently. So, the big question is, is this rally sustainable?

Stupnytska: Well, I think those three factors will determine whether the rally is sustainable or not because the recovery itself in emerging markets is not really so strong. If you look at the data across all EMs, fundamentals are still relatively weak. There are very few countries that are bright spots; like India, for example, is doing quite well; Mexico has been doing okay but it's actually now being affected by the U.S. presidential elections campaign. So, it's very hard to find those countries that have been doing strong.

So, looking at these factors, I think commodity rally is probably close to an end at this point. I think China is quite strong but the fiscal stimulus is likely to be withdrawn again at some point in the coming months because China is on a slowdown trajectory. And finally, in terms of the monetary policy, global monetary policy, I the Fed will hike rates and that will tighten global financial conditions. So, I think we should be cautious when we're thinking about this outperformance going forward.

Wall: And just to your last point, a lot of people don't understand how the decision that the Federal Reserve makes in the U.S. affect global markets and indeed, especially emerging market equities and bonds.

Stupnytska: Well, as I said, emerging markets have benefited massively from ultra-dovish monetary policy, very accommodative global financial conditions. Of course, the hike by the Fed will tighten global financial conditions and so that search for yield environment that all emerging markets have benefited from over the past two years will be coming to an end and so we might see some reversal in capital flows making many emerging markets quite vulnerable to this environment of tighter financial conditions.

Wall: Anna, thank you very much.

Stupnytska: Thank you.

Wall: This is Emma Wall for Morningstar. Thank you for watching.

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Emma Wall  is former Senior International Editor for Morningstar