Emerging-Market Stocks Need End to Trade War, Not More Rate Cuts

(Bloomberg) -- Equity investors clamoring for interest-rate cuts in emerging economies are getting a wake-up call: monetary easing is failing to revive growth impaired by the trade war.

Any stimulus unlocked by lower interest rates is being outweighed by weaker local currencies because trade tensions between the U.S. and China are boosting the dollar. The underperformance of emerging-market stocks relative to developed markets earlier in 2019, the most in more than three years, underscores this inefficacy of looser monetary policy.

The following four factors suggest what’s needed for emerging-market stocks to post a sustained recovery isn’t monetary easing, but a combination of fiscal stimulus and an end to the trade war.

Lagging, Yet Expensive

The MSCI Emerging Markets Index trailed its developed-market counterpart for eight successive months until September as start-of-the-year expectations for a quick resolution of the tariff conflicts failed to materialize.

Yet developing-nation stocks have remained expensive in relative terms.

That’s because lower interest rates put local currencies under pressure, and diminish the dollar value of earnings. So price-earnings ratios look dearer even though stock performance is muted.

Dollar’s Influence

As global investors pile into dollar-denominated assets, local currencies struggle to compensate global investors for their exposure to developing-nation stocks. Even when carry returns are accounted for, gains from local currencies have lagged their developed-market peers by over 1 percentage point in 2019.

This month has brought some reprieve. With the dollar heading for its biggest monthly loss since January 2018, emerging-market currencies have stabilized, making equity returns look appealing in dollar terms.

Financial Baggage

With financial-sector stocks accounting for a quarter of the MSCI gauge, the impact of lower interest rates on those shares is taking a toll on overall equity returns. The gauge for the financial subgroup is trailing the broader emerging-market index by 4.2% this year.

In developed markets, the dominance of technology stocks has protected portfolios from such erosion.

Bonds Benefit

In the past six months, as expectations for Federal Reserve policy turned dovish, the performances of emerging-market equities and bonds have diverged. Dollar-denominated bonds are luring investors wary of currency risk, while local bonds appeal to those betting on rate cuts.

That’s left equities to bear the brunt of global-growth concerns. More monetary-policy easing may deepen this phenomenon, suggesting that growth impulses would have to come from other sources such as fiscal stimulus and an end to the trade war.

To contact the reporter on this story: Marcus Wong in Singapore at mwong547@bloomberg.net

To contact the editors responsible for this story: Tomoko Yamazaki at tyamazaki@bloomberg.net, Srinivasan Sivabalan, Alex Nicholson

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