Emerging markets miss out on 2021 stock rally in developed economies

Emerging market stocks are lagging behind those in developed economies by the most since 2013’s “taper tantrum”, as investors fret that global tightening in monetary policy will trigger a flight away from the asset class.

MSCI’s EM benchmark is essentially flat for 2021 in US dollar terms, including dividend payments. The lacklustre performance starkly contrasts with the index provider’s global gauge of DM stocks that has delivered returns of more than 20 per cent so far this year, bolstered by gains in US and European equities.

EM bonds have also fared poorly, with a fall in prices more than offsetting the relatively juicy interest payments investors earn from holding the debt. JPMorgan’s index tracking debt issued in local currency is down 8.1 per cent for the year to date in US dollar terms. A similar gauge of bonds issued in major developed market currencies is off 1.5 per cent.

Analysts warn that market conditions could deteriorate further after the Federal Reserve announced plans this week to begin reining in its coronavirus crisis stimulus measures. In 2013, the US central bank’s decision to begin easing its economic support measures prompted a heavy sell-off in emerging market assets, part of a broad shake-up in financial markets dubbed the taper tantrum.

“We are heading into a scenario of slowing global growth and rising inflation, with central banks being forced to act. That should be super negative for emerging markets in general,” said Minna Kuusisto, head of global macro research at Danske Bank in Helsinki.

Other risks include a sharper than expected slowdown in the Chinese economy — a key driver of growth across emerging markets for the past two decades — and, for many poor countries, severe delays in vaccination against coronavirus, putting recoveries from the pandemic in jeopardy.

Despite this year’s poor returns and the risks ahead, investors have continued to put money into emerging market assets.

After a bout of panic selling at the onset of the pandemic in March last year, in which foreign investors took $90bn out from emerging market debt and equities, net portfolio flows to EM assets have been positive in all but one of the 19 months since. Almost $790bn has flooded back in, including $25bn in October, according to the Institute of International Finance, an industry association.

One reason is the trillions of dollars pumped into global financial markets by the Fed and other advanced economy central banks during the pandemic. Many governments in emerging markets have seized the opportunity to issue new debt at lower interest rates than those usually on offer. Starved of yield elsewhere, and with attractive valuations compared with assets in advanced economies, foreign investors have piled in.

But that has not been enough to drive prices up. One factor weighing them down, analysts say, has been the threat of rising inflation around the world, something that has pushed bond yields higher across…