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BlackRock Commentary: Staying selective in emerging markets

Wei Li – Global Chief Investment Strategist of BlackRock Investment Institute together with Axel Christensen – Chief Investment Strategist for Latin America, Ben Powell – Chief Investment Strategist for APAC and Beata Harasim – Senior Investment Strategist all forming part of the BlackRock Investment Institute, share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.

Key Points

Emerging Market appeal: We like emerging markets as upbeat risk appetite carries on. We also see big structural shifts creating granular opportunities within countries.

Market backdrop: U.S. stocks hit another all-time high last week thanks to earnings beats, even as U.S.10-year yields ticked up. We think positive sentiment can persist for now.

Week ahead: This week’s U.S. inflation data should show if falling goods prices are still pushing inflation down. We think wage growth will reignite inflation after 2024.

We see broader support for emerging markets (EMs) given the market’s upbeat sentiment on risk assets as U.S. growth holds up, inflation cools and the Federal Reserve prepares to cut policy rates. EMs have been resilient to the latest Fed rate hikes. We get granular through mega forces – big structural shifts we see driving returns. We’re overweight EM hard currency debt on its relative attraction and quality, plus stocks in Mexico and India that are set to benefit from mega forces.

We think the outlook for broad EM assets is supportive as market sentiment stays positive. Robust U.S. economic activity, nearing Fed rate cuts and falling inflation have lessened the market’s recession worries – a boon for EM. As markets priced in sharp Fed rate cuts, 10-year Treasury yields slid from 16-year highs near 5%. That helped tighten the gap between Treasury yields and higher hard currency EM debt
yields. But spreads remain near the long-term average (orange line in the chart). U.S. high yield credit spreads are well below the long-term average (yellow line) – a sign of expensive valuations. We prefer EM hard currency debt and stay overweight. Along with attractive relative value, it includes more countries with higher-quality credit ratings than riskier high yield. Often issued in U.S. dollars, hard currency EM
debt is also cushioned from EM currency weakness as EM central banks cut rates.

While we see broad support for EM assets ahead, selectivity is key because of the divergent performance across EMs. Overall EM stocks underperformed DM peers last year and that trend has persisted into the new year. China’s elevated equity volatility and policy uncertainty prompt us to take above-benchmark risk elsewhere. China’s share of the MSCI Emerging Markets index has edged down while the weight of countries like India has climbed, according to LSEG data. As we stay nimble with our views, we identify country-specific opportunities through the mega forces we track.

The mega force lens

Geopolitical fragmentation is one of five mega forces we see playing out now as competing geopolitical and economic blocs harden. Multi-aligned or “connector” countries like Mexico are increasingly acting as intermediate trading partners between blocs. The U.S. imported more goods from Mexico than China last year for the first time since the early 2000s, U.S. data show.

Demographic divergence is another mega force we track. Many EMs benefit from young, growing populations compared with aging populations in the U.S. and Europe. That’s one reason India – the world’s fastest-growing economy – stands out. India’s talent pool, start-up ecosystem and software firms with a global footprint also make it an up-and-coming hub for artificial intelligence (AI) software, in our view. Digital disruption and AI is a mega force we see being a key driver of corporate earnings. We think these drivers support the momentum of Indian stocks even as 12-month ahead valuations – while below their post Covid peaks – are near their highest levels of the past 20 years. By contrast, those in Mexico are closer to the 20-year average.

These shifts from mega forces favor investment areas like infrastructure, in our view. For example, investment in EMs related to the low-carbon transition – a mega force – will likely be lower than in developed markets due to a higher cost of capital. We think closing the financing gap offers opportunities but will require public sector reforms and private sector innovation.

Our bottom line

We see upbeat market sentiment boosting EM assets and stay overweight EM hard currency debt on still attractive yields. We’re neutral EM stocks overall. Within that stance, we are selective and overweight Mexico and India stocks. But we are monitoring a slew of elections in key EM countries this year, including in India, Indonesia and Mexico.

Market backdrop

U.S. stocks booked another week of gains, with the S&P 500 hitting a new all-time high as earnings beats have boosted sentiment and offset higher yields. U.S. 10-year yields climbed near 4.20%, up about 25 basis points from the start of the year. We think positive risk sentiment can run for a while as markets price in robust U.S. growth, cooling inflation and Fed rate cuts. Yet we think still-elevated wage growth will push inflation back up beyond this year, preventing the Fed from cutting rates as much as markets expect. We think resurgent inflation will eventually become clearer and challenge sentiment.

We’re monitoring U.S. inflation data this week to gauge if falling goods prices will keep pushing inflation lower in 2024 as pandemic mismatches unwind. We think ongoing wage pressures in a tight U.S. labor market will put inflation on a rollercoaster beyond 2024. That’s why the Fed won’t be able to cut rates as much as the market still expects, in our view. In Europe, we look to GDP data for further signs of a divergence in growth among countries.

Week Ahead

Feb. 13: U.S., India CPI data

Feb. 14: Euro area GDP data; UK CPI

Feb. 15: U.S. Philly Fed index; Japan, UK GDP data

BlackRock’s Key risks & Disclaimers:

This material is not intended to be relied upon as a forecast, research or investment advice, and is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy. The opinions expressed are as of 12th February, 2024 and may change. The information and opinions are derived from proprietary and non-proprietary sources deemed by BlackRock to be reliable, are not necessarily all-inclusive and are not guaranteed as to accuracy. As such, no warranty of accuracy or reliability is given and no responsibility arising in any other way for errors and omissions (including responsibility to any person by reason of negligence) is accepted by BlackRock, its officers, employees or agents. This material may contain ’forward looking’ information that is not purely historical in nature. Such information may include, among other things, projections and forecasts. There is no guarantee that any forecasts made will come to pass. Reliance upon information in this material is at the sole discretion of the reader.

The information provided here is neither tax nor legal advice. Investors should speak to their tax professional for specific information regarding their tax situation. Investment involves risk including possible loss of principal. International investing involves risks, including risks related to foreign currency, limited liquidity, less government regulation, and the possibility of substantial volatility due to adverse political, economic or other developments. These risks are often heightened for investments in emerging/developing markets or smaller capital markets.

Issued by BlackRock Investment Management (UK) Limited, authorized and regulated by the Financial Conduct Authority. Registered office: 12 Throgmorton Avenue, London, EC2N 2DL.

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