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New York - The best rally in emerging-market stocks and bonds in seven years is sending bears back into hibernation.
Short interest in the largest exchange-traded fund tracking developing-nation dollar-denominated bonds has fallen to 2.2% of shares outstanding, near the lowest level since 2012, from 13% in mid-February, according to data compiled by Bloomberg and Markit Bearish bets on BlackRock's $26bn emerging-market stock ETF have tumbled to around a 1 1/2-year low of 2.9%, from 15% in January.
Developing-market assets this month have extended a rally started in March as China’s economy stabilized, commodity prices rebounded and the Federal Reserve signalled it would go slow in raising US interest rates.
Traders added more than $1bn to US-traded emerging-market stock and bond ETFs this month through April 15, pushing the total inflow this year to $4.5bn, following an exodus in 2015, data compiled by Bloomberg show.
"We’ve passed the low point," Jens Nystedt, a New York-based emerging-market debt manager at Morgan Stanley Investment Management, which oversees more than $400bn, said by phone. "EM fixed income is still cheap, even after the rally."
BlackRock ETFs
BlackRock’s $6bn iShares ETF tracking emerging-market dollar bonds has gained 6.5% this year, double the return of US Treasuries. The stock ETF rose to a five-month high last week, extending the advance to 22% from its low in January.
Emerging-market dollar debt last week yielded 3.9 percentage more than US Treasuries on average, compared with five-year average of 3.4 percentage points, according to data compiled by JPMorgan Chase In the local-currency bonds, the rally pushed the yields to a one-year low of 6.4%.
While investors are turning less bearish, developing economies need to show more signs of growth momentum for the rally to continue, according to Nystedt, who favours the South African rand and Mexican peso.
"To say that this is an outright inflection point, we need to see one missing piece of this EM rally: an improvement of the underlying emerging-market fundamentals," he said.
The International Monetary Fund last week lowered its 2016 growth projection for developing countries to 4.1%, from 4.3% in October. It still points to a pickup from 4% from 2015, which was the slowest expansion since 2009.
Rally pause
Stocks and currencies retreated on Monday after talks between major oil producers ended in Doha without any agreement on limiting output. The MSCI Emerging Markets Index of shares snapped a seven-day rally to drop 0.7% in Hong Kong, with equity benchmarks in China and Hong Kong leading the decline.
A gauge of currencies fell 0.3%. Chinese data last week showed improvements in exports industrial output and retail sales in March, suggesting the world’s second-largest economy is stabilising.
"While lower oil prices could be a threat, it’s definitely not the same situation we had in January,"said Rajeev De Mello, who oversees about $10bn as the head of Asian fixed income at Schroder Investment Management in Singapore. "We’ve a more positive situation in China. We have the Fed, which is very dovish anyway."
While Schroder Investment had become cautious after the recent rally, it still has a “constructive” bias toward emerging markets, according to De Mello.
Accommodative policies
Bond investors at Goldman Sachs Asset Management concurred that the “accommodative” global monetary policies are “positive” for “selective exposure” to emerging-market debt. China poses a risk as its monetary fiscal stimulus to shore up growth threatens the long-term stability in its financial system, the fixed-income group said in its outlook report for the second quarter. They’re hedging that risk through credit-default swaps and taking a short position in Asian currencies versus the Russian rouble.
"China appears to be prioritising its growth target rather than reforms,” the team wrote in the research note.
"In the near-term, we think this is supportive for financial markets but liquidity-fuelled debt growth seems unsustainable and could create bigger risks over the longer term."
