BlackRock backs EM equities as backdrop 'turns positive'

Analysis from the BlackRock Investment Institute has touted investment opportunities in emerging markets (EM), which withstood “what should have been a big hit” from aggressive monetary policy tightening in developed markets (DM).  

According to BlackRock, in commencing monetary policy tightening ahead of their DM peers, EM central banks helped strengthen balance sheets — further supported by higher commodity prices. 

Despite this resilience, EM equities “underperformed” relative to DM peers, down 20% since June 2021. 

“This slump might be warranted if there were some systemic risk for EM looming – but we don’t see that now,” the BlackRock Investment Institute observed.

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But EM equities bounced in the latter half of 2022, with the resurgence attributed to confidence in the near to medium-term outlook.  

“We think the long EM stock slide and recent rally show a lot of economic damage is now in the price as the EM backdrop turns more supportive,” BlackRock noted. 

The improvement was reportedly buoyed by the US dollar’s retreat and the reopening of China’s economy — expected to continue fuelling growth into the future. 

“We think the backdrop will turn more positive for EM, building on recent resilience,” BlackRock continued.

“EM generally has higher levels of currency reserves, smaller current account deficits, improved external balances and better debt maturity mixes than they did in past DM tightening cycles that sparked volatility. 

“The weaker links among EM are small and not a broader threat, in our view. We think this all helped EM avoid a ‘taper tantrum’-type investor flight when global financial conditions tightened.”

BlackRock pointed to data suggesting investors favoured EM equities in 2022, with inflows into EM equity exchange-traded funds hitting record highs. 

Improvements in EM markets would also be supported by slowing tightening cycles, with EM central banks a year ahead of DM peers in actioning rate hikes. 

“We see DM central banks pausing as the economic damage of their tightening becomes clearer – and as inflation cools from highs but still stays above pre-COVID levels,” BlackRock observed.

Given these tailwinds, BlackRock is favouring investment in selective EM stocks over DM equities. 

“We’re neutral EM debt due to higher commodity prices and prefer it over long-term DM government bonds,” BlackRock stated.

“Long-term DM yields don’t reflect the term premium, or compensation for risk, we think investors will demand in this regime of higher macro volatility.”