After a rough 2018, emerging markets are seeing a comeback this year. The largest emerging market ETFs, like the $63 billion Vanguard FTSE Emerging Markets ETF (VWO) and the $59 billion iShares Core MSCI Emerging Markets ETF (IEMG), have risen 9-11% so far in 2019.
Some ETFs tracking individual emerging markets—especially those tracking China—are up much more. The $2 billion Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR) has surged a cool 27% since the start of the year.
Helping to explain these moves and predict whether the rally can continue is Geoffrey Dennis, an independent emerging market commentator. ETF.com spoke with Dennis, who previously held a position as head of global emerging markets strategy at UBS, to discuss the outlook for emerging markets broadly, as well as the outlook for specific EM countries such as China, Brazil, Turkey and others.
ETF.com: There’s been a strong rally in emerging markets so far this year. Do you think it will continue?
Geoffrey Dennis: Yes. Certainly, the head winds the asset class faced last year were more dramatic than any of us had really anticipated.
The head wind that surprised me the most was the way in which the trade war got ramped up so dramatically. There was really nothing at the beginning of 2018 that gave you any suggestion to the degree of escalation of the trade war, including multiple moves on tariffs by Trump against China and Europe.
The Fed moved significantly, and that led to a big move in the dollar. A rising dollar has always been negative for emerging markets. It sucks money out of EM.
Those two head winds have since abated. It now looks like we’re at “peak tariffs.” We’re probably going to get a resolution to the China trade war. The Fed has also backed away from rate hikes; I don’t think you’ll see any rate hikes by the Fed this year because the U.S. economy is going to slow down.
A quiet Fed that could lower rates at some point later this year, if not in 2020, is going to pull the dollar lower. That’s good for emerging markets.
Earnings growth will undoubtedly slow in the emerging markets this year, but emerging market stocks are 20% off their highs from last year. That’s not warranted based on the trajectory of earnings, especially with last year’s head winds turning into tail winds.
My guess is you're going to see emerging markets go up 15-20% this year, so you've probably seen half the gains you’re going to see.
ETF.com: Chinese stocks have surged this year in anticipation of a resolution to the trade war. ETFs tied to A-shares are up 27% already. With those types of gains, is an end to the trade war already priced in?
Dennis: A number of things are pushing mainland Chinese stocks up. No. 1 is the optimism that there will be a resolution to the trade dispute with the U.S.
No. 2, the slowdown in China is now well-understood, and probably priced into the markets. We are also seeing responses to that in terms of both fiscal and monetary policy. All of that is very important for investors in the Chinese market.
Economic slowdowns generally are not good for any market, especially emerging markets. But once they get priced in, people look ahead to the policy easing and the prospect of the slowdown reversing.
It’s important to understand that China is slowing down from hyper-growth rates of 13% per annum not that many years ago, to a steady state of somewhere around 5%. The slowdown will continue until it hits that steady-state growth rate, because this is a welfare country that can't grow anymore at those advanced rates.
At some point, we'll get a nice surprise and Chinese growth will move up in the short term, but it's still in that long-term trend slowdown. That said, the stock market may be rallying, because the fears of something more serious than that have begun to subside. We'll see if that's right or wrong.
Going forward, Chinese stocks are going to be very much driven by how fast and how much the Chinese economy is slowing. But I think you’ve already seen a good chunk of the gains you're going to see for the year as a whole.