EM Investors Find Solace in History After Dimon's 4% Warning

(Bloomberg) -- Emerging-market stocks slid as U.S. Treasury yields climbed above 3 percent. But that doesn’t mean they’ll crater if 4 percent rates ever become the new normal, as Jamie Dimon and Michael Hasenstab predict.

The shares actually held up pretty well the four notable times Treasuries surpassed 4 percent during the past two decades -- with the caveat that one occasion coincided with the great financial crisis. Apart from that, emerging markets outperformed their U.S. peers in the ensuing three months.

In fact, they even did well the six noteworthy moments when yields climbed above 5 percent in the same period. Only once, from April to July 2006, did they fall. In four of six cases, emerging markets outperformed their U.S. peers, including a 31 percent rally in 1999 compared with an 11 percent gain in the S&P 500 Index.

"There is actually more of a positive correlation. If yields go up, then EM usually performs," said Anastasia Levashova, a fund manager at Blackfriars Asset Management in London, adding that Chinese and Russian stocks would be poised to outperform in that scenario.

MSCI Inc.’s gauge of emerging-market equities rose for a third day on Wednesday, climbing to the highest in a week.

Four percent yields may not be a concern for next month, or even next year. Ten of 46 analysts surveyed by Bloomberg project yields to surpass the mark by the end of 2019. One outlier forecasts it to happen next quarter.

While 4 percent yields may create short-term turbulence for emerging-market stocks, strong fundamentals such as cheap valuations, higher growth and less crowded positioning could outweigh the negatives, said Sonja Gibbs, a senior director at the Institute of International Finance in Washington.

"EM investors are going to be more and more discriminating," Gibbs said. "Countries that are vulnerable on the debt side will be hit harder by the policy adjustments that will need to be made. Equity markets in these countries won’t do as well as those in less-vulnerable EM countries."

Not everyone is so optimistic. Peter Cecchini, the New York-based chief global markets strategist at Cantor Fitzgerald, said emerging markets are at an "inflection point" and that higher developed market rates will create a real headwind for stocks.

Aside from the global financial crisis, the worst stretch for emerging-market equities was during the Mexican "tequila" crisis and Asian financial crisis of the mid-1990s, when Treasury yields climbed as high as 8 percent. Developing nations are in better shape today as they borrow more in their own currencies, said Chris Brightman, chief investment officer at Research Affiliates, a sub-adviser to money managers including Pacific Investment Management Co.

Brightman expects "much higher returns" for emerging-market stocks than their U.S. peers on cheap prices, higher real yields and better currency rates.

"When we examine the historical relationship between U.S. interest rates and EM currencies over the past two decades, we find that rising U.S. interest rates have been accompanied by stronger economic growth, declining volatility and rising FX rates, resulting in higher total returns to EM currencies," Brightman wrote by email.

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