After a surge to record highs in January, emerging-market stocks may have already peaked for the year, according to Morgan Stanley.
There are eight reasons why the MSCI Emerging Markets Index won’t climb any further, strategists led by Jonathan Garner, the chief Asia emerging-market strategist based in Hong Kong, wrote in an 18-page report. The measure has overshot then fallen below the bank’s previously-set year-end target of 1,330.
The arguments include falling copper prices, moderating balance sheets of Group-of-Four nations, peaking sentiment on reflation, tightening liquidity in China, a steadying US dollar, stalling earnings revisions, “euphoric” fund inflows and the relative performance of Korean stocks.
“If we are correct, the key to performance going forward is market, sector and stock selection,” the strategists said. “On the market side, we are most bullish India currently, with a favourable budget further boosting the outlook.”
Morgan Stanley’s bearish warning comes after the MSCI Emerging Markets Index rose as much as 10 per cent in January to a record. The runup came amid optimism that vaccine roll-outs and further US stimulus coupled with a dovish Federal Reserve would create perfect conditions for developing-nation stocks to outperform in 2021.
Strategists from Goldman Sachs Group Inc., UBS Global Wealth Management and Wells Fargo Investment Institute all added to the positive chorus last month, even as technical indicators began signaling an overheating in stocks. The MSCI gauge has tumbled about 2 per cent from a Jan. 25 peak, trimming its year-to-date gain to around 7 per cent.
Here is a breakdown of Morgan Stanley’s eight reasons why emerging stocks have peaked:
Copper prices, which are strongly correlated with the MSCI gauge, are correcting.
The balance sheet expansion of G-4 nations that seems to have played a major role in boosting equity markets is likely to “moderate significantly.” The strategists see this falling to single-digit growth in early 2022 in a deceleration that had been associated with “significant declines” in price-to-earnings multiples in the past.
Ten-year breakeven inflation rates for the US have peaked in January and since corrected, suggesting that near-term sentiment on reflation and the reopening of economies had already reached a high.
Morgan Stanley’s free liquidity indicator for China is up less than 5 per cent year-on-year, compared with over 15 per cent previously and could turn negative in the next few months. This tends to be associated with weak stock performance in China. Consumer sentiment could also correct in the near term due to reduced mainland new year holiday activities.
The US currency has stopped declining. It’s inversely correlated with the performance of MSCI gauges for emerging-market stocks versus their developed peers.
Earnings revisions for the emerging-market index for 2021 and 2022 are showing “early signs of stalling out” after persistent gains since the second quarter of last year.
Emerging market and Asia equity funds have seen “euphoric” inflows. Such episodes have been in tandem with market tops in the past.
Stocks in Korea relative to the broader emerging-market gauge may have peaked in January after an outperformance since March. Major highs in this relative performances have often preceded peaks in emerging stocks’ absolute gains.