Reasons For Second-Half Optimism With Emerging Markets

The iShares Core MSCI Emerging Markets ETF IEMG, one of the largest and most cost-effective emerging markets exchange traded funds, is up 10.70% year to date and that's even with a host of second-quarter struggles at the hands of rising trade tensions between the U.S. and China.

What To Know

When it comes to trade, the good news is that the U.S. and China have at least agreed to talk. Of course, the risk is that the talks will not produce substantial results and the White House could be motivated to revisit or increase its tariff gambit against the world's second-largest economy.

Even with the geopolitical headline risk, investors have been fond of IEMG this year. Year to date, investors have added $5.38 billion to IEMG, a total surpassed by just four other ETFs. Their faith in the inexpensive emerging markets fund could be reward thanks to easy monetary policies in the developed world.

Why It's Important

“Buying emerging markets at a time of decelerating global growth and lingering trade frictions seems ill-timed,” said BlackRock in a recent note. “To be sure, both the economy and trade represent real threats to the asset class, as well as the broader market. That said, for those investors who believe that trade will simmer, not erupt, and that the global economy will continue to grow, there is one powerful argument supporting EM equities: the prospect for materially easier financial conditions.”

Historically, emerging markets assets have been levered to central bank goings on, particularly those of the Federal Reserve. IEMG rallied in June and yes, much of that had to do with ebbing of trade tensions, but much of the recent strength in emerging markets equities is also attributable to investors expecting the Fed to soon lower interest rates.

Put it this way: it wasm't surprising that IEMG closed lower last Friday after a stronger-than-expected June jobs report stirred speculation that the Fed may not pare rates by as much as previously hoped.

“During the past decade both investor sentiment and the broader economy have been increasingly at the mercy of central banks,” said BlackRock. “But while both developed and emerging market stocks benefit from easy money, emerging markets have historically benefited more. This is particularly true in the post-crisis era.”

What's Next

Expect monetary policy to drive emerging markets equity performance over the back half of 2019.

“This is why (recent) announcements were particularly relevant for EM,” said BlacRock. “First the European Central Bank and then the Federal Reserve gave a clear indication of a pivot towards easier money. The subsequent change in rates, the dollar, and credit spreads immediately led to an easing of financial conditions, evident by the sharp drop in the GSFCI.”

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