By Joachim Fels
Emerging markets have been quietly undergoing positive, fundamental change. From negative interest rates to Brexit to the Fed, investors have understandably been preoccupied with matters at hand lately.
From negative interest rates to Brexit to the Fed, investors have understandably been preoccupied with matters at hand lately. But it may be a good time to shift focus and look longer term: Over the past few years, emerging markets (EM) have been quietly undergoing positive, fundamental change that we think will likely increase value in the asset class.
To be sure, EM is a heterogeneous asset class with many different country stories, and the transition in emerging economies is not complete yet. However, EM looks increasingly attractive, especially compared to many advanced economies and markets. Here’s the short version why (for the in-depth version see my colleagues’ Viewpoint: “A Constructive Case for Emerging Markets”):
First, there is an encouraging trend toward more structural reforms and less populist policies in a number of EM countries at a time when populism is on the rise in many advanced economies. Argentina and Brazil have recently seen changes in government that promise more market-oriented reforms. And India made a big step towards a landmark tax reform in early August. Better policies and governance are an important precondition for lowering the risk premium on EM assets.
Progress on structural reform is highly significant. For the past four years, like many, I haven’t seen much value in emerging markets from a fundamental perspective. Manoj Pradhan and I noted in a research paper, “The Broken EM Growth Model,” in 2012: “There is a deeper structural issue that is now being exposed: The traditional EM growth model is broken and the transition to a new model – a rebalancing of EM economies – isn’t going anywhere … a successful switch towards a new growth model requires serious structural reforms.”
Better environment for emerging markets
With the U.S. dollar bull-run behind us following the informal February “Shanghai co-op” agreement and commodity prices having broadly stabilized, the external environment has also become less hostile for EM, which has allowed many central banks to ease policy. This bodes well for some cyclical recovery, especially in places like Brazil and Russia that have been mired in recession.
In addition, while the worry in developed markets (DM) is monetary policy exhaustion, most EM central banks have ample room to ease if needed as inflation is either below target or, where it is not, has peaked and is on its way down.
Finally, most risky DM assets are expensive, and investors have to come to grips with “lower-for-longer” DM rates. This, together with better EM fundamentals underway, suggests to me that the EM rally that started earlier this year has legs to run.
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Joachim Fels is a managing director and global economic advisor at PIMCO.
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