Why some firms say to hold out for an emerging-market rebound

Stocks in developing economies have trailed the U.S. lately, but some investors see a bounce coming.

  • By Akane Otani,
  • The Wall Street Journal
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Shares of stocks from India to Russia and South Africa have slid in August, pulling the MSCI Emerging Markets Index (.MXEF) down 5.5% for the month. [The S&P 500 (.SPX), in comparison, has fallen 2.7%.]

Analysts have attributed the decline to fears that the U.S.-China trade conflict will slow global growth, as well as worries about the U.S. dollar’s extended rally. A stronger dollar tends to dent returns from emerging markets, since it makes it more expensive for developing countries to service their debt that is denominated in dollars.

Emerging markets do have one thing on their side, however: sliding U.S. government bond yields. The precipitous drop in Treasury yields over the course of the year has made the returns that investors can get from emerging markets, especially dollar-denominated bonds, look attractive again, says Gustavo Medeiros, a portfolio manager at investment manager Ashmore.

Mr. Medeiros added in a note Tuesday that he believes bubbling fears of a potential recession in the U.S. over the next year may make emerging markets even more attractive because it could put a cap on U.S. stocks’ gains.

Morgan Stanley Wealth Management, which has an overweight rating on emerging-market stocks, is similarly optimistic. It is betting the U.S. dollar will top out for the economic cycle sometime in 2019 as domestic growth slows.

“This should disproportionately benefit international equities, led by EM equities,” the firm said in a note.

The big risk to that bet? That the U.S. dollar doesn’t, in fact, slow its ascent—and that growth slows even more across emerging markets.

Wells Fargo Investment Institute said at the start of the week [that] it was downgrading its rating on emerging-market stocks to “neutral” from “favorable.” It added that it believes the MSCI Emerging Markets Index will end the year somewhere between 960 and 1060. The index last closed at 980.11.

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