The dollar and bonds remain stable, even as investors continue to postpone their expectations for the start of rate cuts in the U.S. Economic activity is holding up well, and the export cycle is showing signs of improvement. And after a wobbly start to the year, emerging market (“EM”) stocks have rebounded since February, keeping up with gains in the developed world. While policy intervention triggered a turnaround in Chinese stocks, EM ex-China equities performed well, too.
Can the disinflation trend resume without the need for weaker activity? What would it take for concerns over “higher for longer” rates to resurface? And what do the drivers of the EM stock rebound tell us about the prospects for the asset class? Those are some of the questions that TRG analysts and portfolio managers tackled in the latest Global Strategy Meeting (“GSM”).
The disinflation challenge.
Since last month’s GSM discussion, the U.S. disinflation narrative turned more mixed, further challenging the notion that the Federal Reserve (the “Fed”) would cut rates soon and aggressively. Several gauges in the U.S. hinted at a more stubborn picture for prices, including upside surprises in February’s core consumer and producer indices (see Figure 1). As one analyst put it, additional disinflation progress has become a “show me” story. These figures are a reminder that the “last mile” of the disinflation path towards target tends to be the hardest. They also prompted a further rethink of the space for Fed easing during 2024, moving from expectations of over six quarter-point cuts at the start of the year to close to three now. This sharp repricing brought investors’ views in line with the Fed’s projections from mid-December and echoed our prior thoughts that calls for a March start seemed overly aggressive (see TRG’s Macro Conversation: February 2024).
Expectations for a later start to the Fed’s easing cycle notwithstanding, global stocks continued to gain ground to fresh record highs in a context of resilient economic growth, solid earnings, and low volatility. Portfolio managers argued that risk sentiment has not suffered because policy normalization remains the base case, with June now the likely start date instead of March. The Fed’s potential signal of a higher terminal rate (from 2.5%) in its upcoming policy meeting, accordingly, poses a greater challenge to animal spirits. Another likely reason why stocks shrugged off the disappointing inflation news is the continuous stream of signs of resilient economic activity, including firm labor markets. Expectations for U.S. growth this year surged from 1.3% in January to 2.1% now, a trend resembling last year’s when repeated calls for recession failed to materialize (the economy grew 2.5%). Signs of improvement, analysts pointed out, extended beyond the U.S., ranging from further upward revisions to EM growth expectations to the pickup in manufacturing and services surveys globally.
On firmer EM ground?
After underperforming during January, the rebound in EM shares has been roughly in line with developed market benchmarks. Intervention by Chinese authorities – principally through stock purchases by state-owned institutions – halted the local market’s prolonged slump, with shares holding on to recent gains even after the disappointment over the budget announcement that did not incorporate much additional stimulus. China aside, the rest of EM also performed well since February, prompting GSM participants to discuss the prospects for the asset class. In general, they found several signs that hinted at a healthier backdrop for EM stocks going forward and active management opportunities.
The first is that Fed easing is coming possibly around midyear, which tends to be positive for equity market performance. Lower U.S. rates, moreover, give additional space for some EM central banks to keep cutting and others, principally in Asia, to catch up. Second, both the dollar and long-term yields have been relatively stable despite the hawkish adjustment to fewer 2024 rate cuts. Earlier in the year, the hawkish rates rethink drove the dollar stronger, which historically has been a headwind to EM performance. One possible explanation for this recent decoupling in the dollar is that upside economic surprises are becoming more widespread, eroding some of the support from U.S. “exceptionalism.” Third, a supportive EM growth picture in the next two years is expected to coincide with a double-digit earnings-per-share rebound. That is a break from the past decade when EM delivered good economic growth but near-zero earnings growth. Analysts noted that net earnings revisions in EM are still moving lower, but the pace of deterioration is subsiding. Finally, for all the cyclical and structural challenges that China faces, expectations and sentiment are already downbeat; indeed, the consensus for growth is 4.6%, below the official guidance of near 5.0% for 2024.
Asia green shoots.
Within EM equities, the standout performer since February was Asia. The lion’s share of the contribution to the region’s outperformance came from China, which rebounded from multi-year lows following various forms of state-directed intervention. China was, however, only one of the many Asian countries that delivered positive returns over this period. The reasons behind this outperformance, GSM speakers contended, go well beyond the lift to the region from policy developments in China.
Further evidence that the region’s technology-led recovery is gathering momentum is one development with positive implications for Asian markets (see TRG Macro Mosaic, January 25th, 2024 - The Sum of All Fears: Will Global Forces Weighing on Asia Recede in 2024?). Semiconductor exports from Korea, for example, soared 55% in the first 10 days of March compared to the same period a year earlier, extending an accelerated trend (see Figure 2). China’s technology exports are also recovering, albeit with a longer lag than usual relative to some leading indicators – a lag that may be the result of firms gradually adapting to trade restrictions. Manufacturing surveys are improving, too, with the latest global PMI rising above the 50 neutral threshold for the first time in 18 months. And that is good news for Asian economies that are more leveraged to the global export and semiconductor cycles. A second potentially positive driver for Asian assets was the Bank of Japan’s (“BoJ”) March exit from its negative interest rate policy and yield curve control (“YCC”). Leading up to the March 18th decision, the case for an exit, which markets gave near even odds of happening, strengthened after better capex data, higher labor union wage demands, and media reports that discussions over a post-YCC framework were well advanced. Our Asia specialists singled out the importance of the central bank’s forward guidance and the exchange rate’s reaction to it. After all, the BoJ’s monetary policy divergence resulted in the loss of the yen as a key currency anchor for Asia, contributing to the relative weakness in many of the region’s currencies.
DISCLAIMER
The information provided herein is for educational and informational purposes only, and neither The Rohatyn Group nor any of its affiliates (together, “TRG”) is offering any product or service hereby. The information provided herein is not a recommendation, offer, or solicitation of an offer to buy or sell any security, commodity, or derivative, nor is it a recommendation to adopt any investment strategy or otherwise to be construed as investment advice. Any projections, market outlooks, investment outlooks or estimates included herein are forward-looking statements, are based upon certain assumptions, and should not be construed as an indication that certain circumstances or events will actually occur. Other circumstances or events that were not anticipated or considered may occur and may lead to materially different outcomes. The information provided herein should not be used as the basis for making any investment decision.Unless otherwise noted, the views expressed in the content herein reflect those of the participants in the GSM as of the date published and are not necessarily the views of TRG. In fact the views of TRG (and other asset managers) may diverge significantly from certain of the views expressed in the content herein. The views expressed in the content herein are subject to change without notice, and TRG disclaims any responsibility to furnish updated information in the event of any such change in views. Certain information contained herein has been obtained from third-party sources. While TRG deems such sources to be reliable, TRG cannot and does not warrant the information to be accurate, complete or timely, and TRG disclaims any responsibility for any loss or damage arising from reliance upon such third-party information or any other content provided herein.Exposure to emerging markets generally entails greater risks and higher volatility than exposure to well-developed markets, including significant legal, economic and political risks. The prices of emerging market exchange rates, securities and other assets are often highly volatile and movements in such prices are influenced by, among other things, interest rates, changing market supply and demand, external market forces (particularly in relation to major trading partners), trade, fiscal and monetary programs, policies of governments and international political and economic events and policies. All investments entail risks, including possible loss of principal. Past performance is not necessarily indicative of future performance.The information provided herein is neither tax nor legal advice. You must consult with your own tax and legal advisors regarding your particular circumstances
