Several factors, on the surface, have contributed to a sharp rebound for beleaguered emerging markets around the world so far this year. In 2016, we've seen a decent rebound for commodity prices, a fizzling out of the rally for the dollar, and investor flight from weakening financial stocks in Europe.
All of these developments are bullish for the various emerging markets—places like Brazil, Russia, and India. At least, we can say they're bearish for the mature, advanced economies. This usually drives more capital into alternatives such as EMs.
A major index tracking emerging market stocks (the MSCI Emerging Markets index) has risen 22% since the beginning of the year—and more than half of those gains have come in the last month alone. The MSCI index had been at a 7-year low before the liftoff.
The smart money doesn't seem to be convinced that this rally is going to last. Analysts at UBS and Barclays cite transient circumstances as fueling the rally: "dovish Federal Reserve, stability in China’s economy and rises in oil prices."
Weak Support for Emerging Markets
There's more weakness underlying the EM rally than initially meets the eye, as well. The jump in stock prices in emerging market (Brazil is one prominent example) has come amid unusually low trading volumes. Low volumes are typically a sign that the action taking place is not sustainable, or shouldn't be trusted as representative of a real trend. Amid low-volume trading activity, a smaller number of participants can (and do) have a disproportionate impact. The volumes during this year's rally have been barely half of the running 5-year average.
Part of the reason for such low trading volumes is that many investors and traders are remaining on the sidelines. They are sticking to their bearish predictions about the performance of EMs in general. According to the London-based Pioneer Investment Management Ltd., "The economic slowdown in emerging markets will continue until 2018." For context, Pioneer has outperformed 98% of its peers in the fund management business over the last three years.
Even more concerning for emerging markets are the worsening fundamentals despite the surge in stock prices. These countries have been seeing weak export numbers, an 11-month slump in manufacturing, and dwindling corporate profit margins. These are hardly the signs of robust economic activity.
Moreover, these developing economies have benefited greatly from the dollar cooling off, which boosts their own currencies. However, emerging market currencies are becoming more and more closely tied to the price of oil. This should be another worrisome sign, as crude oil has been both volatile and mired in oversupply. The recent rally that saw crude prices touch back above $40 per barrel is almost surely running out of steam. Not surprisingly, both WTI crude and Brent crude, the two global benchmarks, lost over 4% on Friday to close out the week. When oil prices come down, so too will the currencies of these emerging markets.
The key takeaway should be the following: instead of chasing yield from fleeting rallies, investors who are rightly worried about the economic outlook should choose the ideal hedge in times of turmoil, precious metals.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.