Whatever happened to the EM rally?

For emerging market investors, 2019 began promisingly. The US Federal Reserve has kept back from continuing a series of interest rate hikes that hurt EM assets last year while fears of a more bruising trade war between the US and China have abated. However, a January rally in the bonds and stocks of many developing economies has since waned.  Given the more benign backdrop delivered by a change in policy from the Fed, the deterioration of EM markets to continue their momentum may rest on the evidence that investors opened the year with a good deal of exposure to them.

According to the Institute of International Finance, an industry association that gathers EM data, the IIF examined the balance of payments data from 23 emerging economies, broken down by cross-border flows and moves in asset prices, to determine how the value of foreign holdings of each countries’ securities, such as equities and bonds, have changed. Their research underscores that a decade of quantitative easing by Western central bank triggered a torrent of offshore capital into EM assets. Between 2010 and 2018, investors poured capital into most EM countries, with only Russia and Hungary missing out over the cycle.

Although the effect of fluctuations in the prices of EM assets was less uniform, the clear trend was that the value of foreign holdings of securities, as a share of total GDP, surged across EMs. And despite last year’s rout in EM assets, most foreign investors received the hit to valuations without diminishing their risk. The IIF’s data indicate that flows were moderately negative at best. The analysis reveals that fund managers went into the year with substantial exposure to EM assets, placing a restraint on their hunger for more. Until there are signals that global growth, and the Chinese economy, in particular, can gain momentum, the EM rally may well remain on pause.