Emerging market stocks and bonds rose, and the last time it was so strong was in 2009 after the financial crisis.

Driven by the weakening dollar, attractive valuation and artificial intelligence boom, emerging market assets are welcoming a strong recovery, and their stock market performance has set the best start since 2009. This broad rise marks that emerging markets are returning to the vision of global investors with a strong attitude after more than ten years of downturn.

Since the beginning of this year, the MSCI benchmark index, which measures the stock markets in emerging markets, has soared by 28%, which is the biggest increase recorded in the same period since 2009, when it recovered after the global financial crisis. This performance far exceeds that of developed economies, whose MSCI index rose by less than 17% in the same period.

The bond market also performed well. An index in JPMorgan Chase that tracks local currency government bonds of developing countries rose by 16%, the biggest increase since 2016. The expectation that the Fed will cut interest rates, combined with the high yields of emerging markets themselves, is attracting a large influx of funds seeking returns.

Analysts believe that after 15 years of mediocre performance, "favorable factors have finally begun to gather." Ian Simmons, senior portfolio manager of Fiera Capital, pointed out that the weakening of the US dollar is the "most important variable", which paves the way for the strong return of emerging market assets and indicates that investors may be reassessing the long-term US-led market structure.

A weak exchange rate of the US dollar usually improves the financial environment of developing countries, because it reduces the cost of repaying dollar-denominated debts. Ian Simmons said that whether it was "intentional or unintentional", US President Trump did seem to have contributed to a weaker dollar.

The expected interest rate cut by the Federal Reserve also injected momentum into the market, supporting investors to use US dollars to finance and invest in arbitrage transactions of high-yield local currency bonds. Damien Buchet, chief investment officer of Principal Finisterre, said that about half of the returns of JPMorgan Chase’s local currency bond index this year came from the appreciation of foreign exchange. He added, "Central banks are in a loose mode, while the dollar is weakening."

In addition to the favorable macro environment, two major investment themes also provide solid support for the rising trend of emerging markets: artificial intelligence and high yield.

In the stock market, the global craze for artificial intelligence is spreading to emerging markets that dominate the field of chip manufacturing. South Korea’s Kospi index and Taiwan Province’s Taiex index both hit record highs in recent days, and investors have increased their bets on manufacturers of chips, power equipment and other necessities for AI data centers. The market value of TSMC, the world’s largest chip maker, has risen sharply, and its weight in the MSCI emerging market benchmark index has reached about 11%.

In the bond market, high real rate of return is the main factor to attract investors. Central banks in large emerging markets such as Brazil and South Africa have been cautious in cutting interest rates, while countries with fragile financial conditions such as Turkey have maintained double-digit interest rates to attract capital. Even in Asian economies with low interest rates such as Thailand and Malaysia, the decline in inflation has made local currency bonds attractive to local investors. According to the data of S&P Global Ratings, in order to meet investors’ demand for high yield, the issuance of local currency government bonds in 17 large emerging markets (excluding China) has reached a record $286 billion this year.

Although it has experienced a round of rise, the valuation of emerging market stocks is still far lower than that of US stocks, which leaves room for subsequent performance. This year’s rally is largely driven by "valuation repair", that is, the ratio of stock price to expected return has been improved.

At present, the expected price-earnings ratio of stocks in MSCI emerging market benchmark index is about 14 times, while the S&P 500 index is as high as 23 times. Vivian Lin Thurston, portfolio manager of William Blair, said that "there is a huge valuation gap between the United States and the rest of the world, and this gap is still significant".

In contrast, India’s stock market has become a conspicuous laggard in this emerging market rebound, partly because its share price has been pushed up to an expensive level comparable to that of US stocks, while corporate profits have failed to meet expectations. A fund manager said that the revival of investors’ interest in emerging markets also reflected the "twilight of American exceptionalism". The instability and repeated policy-making in the United States made it "behave more and more like an emerging market", prompting investors to look elsewhere.

It is worth noting that despite the bright performance of emerging market assets, the overall allocation of global funds seems to have not kept pace with the rebound.

Simmons of Fiera Capital pointed out that emerging market assets "are currently in a very low proportion and allocation level in the portfolio". This shows that if more investors follow this trend in the future and shift their funds from developed markets to emerging markets, this round of rally may still have considerable upward potential.

In addition, the breadth of this rebound is also worthy of attention. It continues under the circumstance that Argentina (a typical trading object of emerging markets, but now it has faded out of the sight of most global investors) is brewing a debt crisis again, which shows that investors’ interest in emerging markets is extensive rather than partial.

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