While some volatility in EM stocks is to be expected, economists at Charles Schwab believe there are five key reasons EM stocks can still likely perform well should rates continue to climb this year.
“EM stocks and bond yields usually move in the same direction, both driven higher by rising prospects for growth and inflation. After periods of negative correlation (when bond yields and stock prices move in opposite directions) ahead of the recessions of 2008 and 2020, there was a return to the positive relationship typical of an economic expansion.”
“The sharp rise in the US dollar and plunge in commodity prices during 2014-15 helped to undermine the performance of EM stocks in that period. The opposite has been taking place since the rise in yields began last year, with the dollar weakening (lifting EM currencies) and commodity price rising. If the trend of a weakening dollar continues, as we anticipate, this combination may act as a strong offset to any potential drag from higher interest rates.”
“There has been no indication of a sharp worsening of financial conditions in emerging markets, which could hurt stocks, from the recent rise in rates. This isn’t too surprising given that central banks see current inflation pressures as partly transitory and remain committed to providing ample monetary stimulus.”
“If the US can add further fiscal stimulus while keeping inflation near target levels and maintaining easy monetary policy, other developed and emerging market economies may become less inclined to tighten policy prematurely.”
“It’s unlikely that stocks would react negatively if bond yields were to continue to rise to meet the dividend yield on EM stocks. The US 10-year Treasury yield rose to 1.46% at the end of February, and the yield on corporate bonds, measured by Bloomberg Barclay’s Global Aggregate Corporate Bond Index, rose to 1.64%. Yet, these yields do not yet provide competition to the notably higher EM stock dividend yield of 1.8%.”
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