Has the emerging market rally fizzled out?

The average emerging market fund is up 60% over two years, but there are signs the rally is starting to peter out.

Emerging markets have come under heavy selling pressure since the start of May. Sparked by a strong US dollar, international investors have been rotating out of emerging market equities, bonds and currencies.

Certain countries have suffered more than others. Argentina and Turkey saw their currencies hit the hardest, prompting the former to raise interest rates to 40% to try and stem the tide.

However, emerging markets in general took a hit across all asset classes. Over the past month, the iShares MSCI EM ETF USD Acc GBP returned -1.13%, compared to returns of 2.21% for the iShares MSCI World ETF USD Dist GBP. Active managed equity funds also took a hit, as international investors cashed in their chips.

The change in sentiment towards emerging markets comes just a couple of months after emerging markets were widley tipped for 2018.

Emerging market equities suffered a miserable run from 2011 to 2016. Since the region returned to favour two years ago, the average fund in the Investment Association global emerging market sector has surged by 60%, according to FE Trustnet. Our sister site, Money Observer's cover story back in May 2016, noted that emerging market valuations were near historic lows, presenting a value opportunity for canny investors.

Now, with the region once again facing selling pressure, is the emerging market party over?

Not according to Russ Koesterich, a portfolio manager for BlackRock's global allocation team, at least when it comes to emerging market shares. "For equities in particular, changes in the dollar have historically had a modest impact on relative returns," he notes.

The shock of a stronger dollar, he says, has already been felt.

He adds:

"The dollar's sharp rebound is arguably the result of a rapid and violent unwind of a very crowded short trade. Recent changes in positioning suggest much of this adjustment has already occurred."
He adds the prospects for emerging market growth is still strong, which should support equities. Koesterich, argues the world economy should see an "acceleration in capital spending [that] should be supportive of global trade, and by extension emerging markets."

He adds: "For investors who have already lived through the volatility, this is probably the wrong time to sell."

Markus Stadlmann, chief investment officer at Lloyds Bank Private Banking, is more hesitant. Pointing out that over the past three months (to 30 April) emerging market shares have declined by 5.5%, he argues:

"Emerging markets could be the asset class to watch for all investors. The question is whether corporate profit and revenue growth has peaked in some countries, with Brazil, Turkey, South Africa and Malaysia on our watch list."