(Bloomberg) — China’s stock selloff has caused emerging-market equities to erase all their gains for the year.
The MSCI Emerging Markets Index — which has more than a third of its weighting in China — wiped out what was left of its 2021 advance after sliding 2.4% on Monday. Strategists are divided on the outlook. State Street Global Markets prefer developed markets as they are ahead in vaccination rates, while AllianceBernstein says EM assets will be supported by a recovery in risk appetite.
“We’re more bullish on DM versus EM,” said Daniel Gerard, a senior multi asset strategist at State Street Global Markets in Boston. He is especially negative toward Southeast Asia, where surging virus outbreaks are weighing on earnings, and Mexico, while preferring countries like Brazil and South Korea.
Emerging-market stocks, once the barometer for optimism on global growth, have given up a 12% advance since February on speculation the resurgence of virus cases and mobility restrictions will push down earnings. In contrast, the higher vaccination rates and economic reopenings in countries such as the U.S. and U.K. have boosted developed-market equities with the MSCI developed-market index up 14% this year.
The emerging-market equities benchmark slid as much as 2.4% Tuesday as unverified rumors that U.S. funds were offloading China and Hong Kong assets spurred a renewed bout of selling. The Hang Seng Tech Index, a gauge of many Hong Kong-listed Chinese stocks, plunged as much as 10%, while the yuan slid to its weakest since April against the dollar. Even Chinese bonds were dumped.
The crackdown in China is adding to concerns as investors assess how far officials will go as they seek to reshape the world’s second-largest economy. Weakening currencies also pose a threat to emerging-market firms that have debt denominated in currencies such as the dollar and euro.
Read more: China Crackdown Rocks Investors: ‘Everybody’s in the Crosshairs’
“It is too early to rotate back toward emerging-market stocks, particularly as the Fed’s recent policy shift lends some near-term support to the dollar,” said John Bilton, head of global multi-asset strategy at JPMorgan Asset Management in London.
Stocks in Malaysia and the Philippines are among the worst performers in the world this year as Southeast Asia battles a resurgence of the coronavirus, while in China, a gauge of Internet shares has tumbled by more than a third since a February peak amid a crackdown on the technology sector.
Slowing growth in China, once the world’s leader in the pandemic recovery, poses another challenge as its export demand eases. The prospect of the Federal Reserve starting to withdraw stimulus is also putting pressure on developing-nation currencies.
Against this backdrop, emerging-market stocks continue to get cheaper. The developing-market index is trading at 13 times forward price-to-earnings, more than two standard deviations below its five-year average relative to its developed-market peer.
State Street’s Gerard prefers emerging-markets that are more geared toward the global rebound from Covid-19, including commodity-rich countries like Brazil, and the technology markets of South Korea and Taiwan.
“We will continue toward a market driven by earnings growth rather than multiple expansion as extreme liquidity provision measures ease,” he said. “Asean, Indonesia, Malaysia will have a harder time with the recovery.”
Still, there are those who expect emerging markets to eventually outperform.
“Not only will many EM markets be viewed as plays on cyclical recovery that’s less fully priced, but the large-cap tech names within EM that weigh so heavily on the index will probably get another look,” said Morgan Harting, a money manager at AllianceBernstein in New York. “I’d expect some of the sector strategists to rebalance back to the China names as some of the regulatory concerns there are clarified.”
Read more: Beijing’s Tech Crackdown Makes China Model the Law of the Land
Investors are also overlooking the transition to the new economy in emerging markets, according to HSBC Asset Management, pointing to sectors such as financial technology to e-commerce and 5G.
“This pivot brings about stronger for longer, less cyclical earnings growth and ultimately higher valuations for companies aligned with the new economy,” said Stephanie Wu, head of emerging markets equity at HSBC Asset in London.
(Adds detail on Tuesday’s market selloff in fifth paragraph)
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