World Economy

Turn of Tide in EM Flows

Turn of Tide in EM FlowsTurn of Tide in EM Flows

One of the most bruised asset classes in financial markets may be about to turn a corner. Emerging markets have had a horrid few years as investors pulled funds amid the prospect of weaker growth in once-booming economies, volatility in China's markets and likely higher interest rates in the US.

In 2015, capital outflows from emerging markets were the heftiest since the late 1980s. Now, there are tentative signs of recovery, CNBC reported.

Fund flows into emerging markets turned flat in February after seven straight months of outflows, according to data from the Institute of International Finance released on Monday.

"We estimate that the reversal of portfolio flows which began in July 2015 all but stopped in February, with outflows dwindling to $200 million," the global financial industry association said. Outflows of $1.1 billion from emerging market equities were offset by inflows of $900 million to emerging market debt markets, it said.

The IIF attributed February's reversal to "an unusually large" shift in market expectations away from anticipating the US Federal Reserve would hike interest rates as many as four times this year to forecasts that suggested the central bank could stay on hold or even cut rates.

Stanching the outflows in February came despite a volatile month for emerging markets. "The path during the month followed a roller coaster ride of risk appetite," the IIF said. "In early and late February, oil prices rebounded, equity prices rose, and measures of volatility moderated. In between those periods, we saw moves in the opposite direction."

There are some signs February's flow reversal might not be a one off, with analysts turning more positive on emerging markets.

Going Bullish

Bank of America-Merrill Lynch said it was ending its bearish call on emerging markets and shifting to a "tactically bullish" stance.

BofA-ML points to some key changes in the economic outlook: "US data are better, Chinese monetary policy is easy, and leads emerging market purchasing managers indexes, which correlate with emerging market/Asian equities."

Another change is that policymakers are starting to look livelier, the bank said in a note Monday.

"Policymakers have begun to show less indifference to the 'dark message of the markets' and more flexibility," the bank said. "In the past few days, Governor Zhou Xiaochuan of the People's Bank of China, Governor Haruhiko Kuroda of the Bank of Japan, and Federal Reserve thinker James Bullard and Dallas Fed (President) Robert Kaplan have all come up with soothing monetary policy views, in line with our concerns that markets are (performing) consistent with serious deflation and earnings recession risk."

After the BofA-ML note was published, PBOC announced late Monday that it would cut banks' reserve requirement ratio by 50 basis points, in a measure aimed at boosting liquidity as well as capital investment.

Markets globally have shuddered over the past few months, with emerging markets particularly hit by outflows, amid concerns over China's slowing economy as well as whether the US Federal Reserve would tighten monetary policy too quickly. The MSCI Emerging Markets stock index is down nearly 7% year-to-date and more than 25% over the past year.

But BofA-ML also noted it still has longer term concerns over Asia and emerging markets, such as record-low earnings margins, relatively high valuations, record-high private sector debt to gross domestic product and high valuations as well as concerns over China's debt and policy challenges.

Last week, Citigroup also upgraded emerging market equities to overweight. "As our foreign exchange strategists no longer forecast a strong US dollar, this should remove one of the major headwinds for emerging-market equities," Citigroup said in a note last week.

It expects the MSCI Emerging Market index will rise around 10% in US dollar terms by end-2016. On Tuesday, the index was at 740.33; Citi's year-end target is 820.