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Currency Trading: Bargain-Hunting Investors Pile Into Emerging Markets -- WSJ

3 Apr 2017 6:32 am
By Ira Iosebashvili 

Investors are once again piling into emerging markets, drawn by an improving global economic outlook and favorable stock valuations.

The MSCI Emerging Markets stock index rose to a nearly two-year high in March, led by rallies in China, Korea and India. The Mexican peso is within striking distance of its biggest monthly gain in more than two decades, while the South African rand, Russian ruble and Brazilian real are up 30% or more against the dollar from their lows of 2016. Some $30 billion flowed into emerging market assets in March, the biggest inflows since January 2015, according to the Institute of International Finance.

Even following those gains, many investors believe developing markets promise potentially better returns than the U.S., where a postelection rally has driven the Dow industrials and other major indices to new highs and pushed price/earnings ratios further above their long-run average.

Emerging-market stocks are trading at a 26% discount to those in developed markets, based on estimated earnings over the next 12 months, analysts at UBS Wealth Management said. The average discount over the past 10 years has been 17%.

Bond yields have fallen in emerging markets during a yearlong rally, but remain well above the ultralow levels prevailing in the U.S., Japan and Europe.

"Emerging markets are one of the few places in the world where valuations still look cheap," said Ryan Caldwell, chief investment officer at Chiron Investment Management. "There's just not a lot of value left in developed markets."

Emerging markets' rally reflects expectations that a tepid global expansion will pick up speed this year with the Federal Reserve only gradually tightening policy in the U.S. This so-called goldilocks outlook should be supportive of asset prices while limiting volatility in markets, many analysts say.

Big developing economies such as Brazil and Russia are emerging from recessions, while China appears to have slowed an economic decline through massive stimulus programs. And a pickup in Europe and Asia has boosted demand for commodities, a key export for many emerging markets.

A weaker dollar is helping as well. Expectations that the new presidential administration will boost the economy through fiscal stimulus pushed the dollar to a 14-year high in the weeks after the election. But the U.S. currency fell to its lowest level since November on March 27, after the White House failed to repeal the Affordable Care Act, throwing the rest of President Donald Trump's legislative agenda into doubt.

The dollar's weakness is good news for emerging-market economies that have borrowed heavily in dollars over the years and fear that a strengthening U.S. currency will make it more difficult to service those obligations.

Mr. Caldwell said his fund owns Chinese stocks such as online commerce company Alibaba Holding and Russian financials, including state-owned lender Sberbank. It also has purchased shares in Indian, Czech and Polish companies, he said.

UBS Wealth Management increased its position in the Mexican peso last month, confident that the battered currency will benefit from the combination of a more dovish Fed and a series of rate increases by the Bank of Mexico that have made the currency an attractive target for yield-seeking investors. The peso fell to a record low after the U.S. election on fears that Mr. Trump would push through protectionist policies that would damage Mexico's export-dependent economy.

Those concerns have abated in recent weeks on a more conciliatory tone from the administration in regards to trade policy. The peso is up nearly 11% from its January lows. The iShares MSCI Mexico Capped exchange-traded fund, which invests in the nation's publicly traded companies, is up more than 16% this year.

"We think the rhetoric has improved," said Jorge Mariscal, emerging-market chief investment officer at UBS Wealth Management. "There was uncertainty, but now it looks like Mexico and the U.S. are more likely to do something constructive."

There are plenty of reasons to be cautious in emerging markets, including a history of hard-to-predict boom-and-bust cycles. The MSCI Emerging Markets Index declined for three years in a row before notching a gain in 2016.

A sharp upturn in U.S. economic data would probably bolster the case for more aggressive tightening by the Fed, a move that would likely boost the dollar and pressure debt-heavy emerging-market economies. Signs that Republican efforts to pass a tax bill are gaining traction also could boost the U.S. currency, analysts said.

Commodity prices are another danger: Prices for oil, copper and other raw materials have rallied this year, benefiting the developing economies that rely on commodities exports. Oil prices have slumped more than 6% in March, however, dragged lower by rising shale-oil production and inventories in the U.S.

Still, with valuations rich elsewhere, few are willing to turn their back on emerging markets, said Kit Jucjes, a strategist at Société Générale.

He has recently urged clients to buy the Indonesian rupiah and Indian rupee.

"There aren't many people who can afford to hide under a rock," Mr. Juckes said. "Just make sure you are not the last one off the bus."

Write to Ira Iosebashvili at ira.iosebashvili@wsj.com

(END) Dow Jones Newswires

April 03, 2017 02:32 ET (06:32 GMT)

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