Firmer commodity prices and attractive valuations could support emerging markets in 2017, but analysts and strategists say heightened geopolitical risks temper their outlook about the broad sector.
Aside from the fundamental factors that may affect individual countries, markets are dealing with several unknowns right now: the potential pace of U.S. monetary-policy tightening; a stronger U.S. dollar; the possibility of foreign-trade policy changes under President-elect Donald Trump; a potential change in the U.S.’s relationship with China and Russia; and the rise of euro-skeptic political parties in Italy and France, to name a few.
“The things that make [forecasting an outlook] complicated is we don’t know what some of the policies are going to be,” says Eamon Aghdasi, an emerging market strategist at State Street Global Markets.
Financial markets are focused on Federal Reserve monetary policy and the potential for fiscal stimulus under Trump, so they are pricing in the likelihood of higher inflation, a stronger dollar and a steeper yield curve, he says.
“There has been a sell-off in emerging markets based on this presumption where the U.S. has looser fiscal policy and the U.S. economy starts to rebound on the back of that,” Aghdasi says. “But the rest of the world is mired in this continuing relative mediocrity on the macro front . . . which will be bad for emerging markets. Generally, I’m sympathetic to that argument, but I feel like for 2017 the markets to some extent have taken their eye off the ball in terms of really prioritizing a hierarchy of risk for emerging markets.”
Francis Rodilosso, head of fixed-income ETF portfolio management at Van Eck, says the current global political and economic climate is “creating more questions than answers so far and a much wider range for potential outcomes. In a way that’s saying there’s more risk in the market and are you getting priced appropriately?”
Rodilosso says the emerging-market currency selloff on the resumption of the dollar trade and underperformance of sovereign and corporate credit is a fair reaction and nothing dramatic outside of some local currency moves.
Current weakness in emerging markets makes relative valuations “very attractive,” particularly in relation to the U.S., says Crit Thomas, global market strategist at Touchstone Investments.
“From a longer-term perspective, I like that,” he says. “And then with emerging markets you do get exposure potentially to better growth, a better demographic profile, so you do have some of these bigger picture positives. But in the near-term we still face some headwinds and some cross currents as well.”
Because of the known unknowns, market watchers say investors should be cautious before making big bets.