There are early indications of this shift, as equity benchmarks have outperformed local-currency bonds since the beginning of July. Traders have also started to join in on the rally, with Bank of America Corp. reporting $4.1 billion inflows into emerging-market equities in the week ending August 2, and continued inflows in the previous three weeks.
It suggests that local-currency bonds, which have been the preferred investment in emerging markets this year, are now facing stronger competition from stocks. While some investors, such as Bank Julius Baer & Co. and Brazil’s Legacy Capital, argue that there are still opportunities in debt markets, they believe that bigger gains will come from stocks.
The macro backdrop is also in favor of developing nations. Over the next three years, emerging economies are expected to grow nearly three percentage points faster than advanced nations, primarily led by China (albeit at a slower pace) and India. In July, analysts raised their earnings forecasts at the fastest rate in 18 months, according to Bloomberg data.
“The main factors driving equity performance will be a favorable macro environment, particularly in countries like India, Indonesia, and Brazil, alongside strong earnings growth driven by consumption and investment strength,” said Ashish Chugh, a money manager at Loomis Sayles in Boston.
The MSCI Emerging Markets Index surged almost 6% last month, marking its best performance since January. In contrast, indexes tracking dollar and local-currency EM debt gained less than 2%.
In July, capital inflows into emerging-market assets jumped by 5.5%, the largest increase since November. In the past four weeks alone, investors in US exchange-traded funds have invested a net $2.61 billion into emerging-market stock ETFs, while only allocating $269 million to bonds. This may just be the beginning, as global investors still under-own emerging-market equities by approximately $600 billion, following a massive $5.7 trillion selloff in the previous year, as estimated by GW&K Investment Management.