The best rally in emerging-market stocks and bonds in seven years is sending bears back into hibernation.
Short interest in the largest exchange-traded fund tracking developing-nation dollar-denominated bonds has fallen to 2.2 percent of shares outstanding, near the lowest level since 2012, from 13 percent in mid-February, according to data compiled by Bloomberg and Markit Ltd. Bearish bets on BlackRock Inc.’s $26 billion emerging-market stock ETF have tumbled to around a 1 1/2-year low of 2.9 percent, from 15 percent in January.
Developing-market assets this month have extended a rally started in March as China’s economy stabilized, commodity prices rebounded and the Federal Reserve signaled it would go slow in raising U.S. interest rates. Traders added more than $1 billion to U.S.-traded emerging-market stock and bond ETFs this month through April 15, pushing the total inflow this year to $4.5 billion, following an exodus in 2015, data compiled by Bloomberg show.
“We’ve passed the low point,” Jens Nystedt, a New York-based emerging-market debt manager at Morgan Stanley Investment Management, which oversees more than $400 billion, said by phone. “EM fixed income is still cheap, even after the rally.”
BlackRock’s $6 billion iShares ETF tracking emerging-market dollar bonds has gained 6.5 percent this year, double the return of U.S. Treasuries. The stock ETF rose to a five-month high last week, extending the advance to 22 percent from its low in January.
Emerging-market dollar debt last week yielded 3.9 percentage more than U.S. Treasuries on average, compared with five-year average of 3.4 percentage points, according to data compiled by JPMorgan Chase & Co. In the local-currency bonds, the rally pushed the yields to a one-year low of 6.4 percent.
While investors are turning less bearish, developing economies need to show more signs of growth momentum for the rally to continue, according to Nystedt, who favors the South African rand and Mexican peso.
“To say that this is an outright inflection point, we need to see one missing piece of this EM rally: an improvement of the underlying emerging-market fundamentals,” he said.
The International Monetary Fund last week lowered its 2016 growth projection for developing countries to 4.1 percent, from 4.3 percent in October. It still points to a pickup from 4 percent from 2015, which was the slowest expansion since 2009.