Morgan Stanley, AQR, and BofA Are All In - Are Emerging Markets The Next Big Bet For Wall Street?
2min read Wall Street investors in emerging markets, after years of missing out on the soaring U.S. stock market, are finally seeing opportunities. Firms like Morgan Stanley Investment Management, AQR Capital Management, Bank of America, and Franklin Templeton are betting that the tide may finally turn in favor of equities in developing markets.
Bank of America's Michael Hartnett calls it the "next bull market." AQR predicts that over the next 5 to 10 years, these markets could deliver annual returns of nearly 6% in local currency terms, outpacing the 4% gain expected for U.S. stocks in dollar terms.
Despite a recent rebound in the S&P 500, the index was flat year-to-date as of last Friday's close, while the emerging markets index had risen 10%. This rally has sparked hopes that the dismal performance of emerging markets over the past 15 years- during which the U.S. benchmark surged over 400% while developing markets gained just 7%- may finally be ending.
As U.S. President Donald Trump wages a trade war, factors such as a struggling dollar, volatile S&P swings, and doubts about the safe-haven status of U.S. Treasuries are increasingly diverting investor attention away from America. Concerns over ballooning debt and deficits prompted Moody's to downgrade the U.S. credit rating last Friday, adding further headwinds for U.S. stocks.
"The depreciation risk of the US dollar is a wake-up call for investors," said Franklin Templeton investment strategist Christy Tan, who views developing-market bonds as an alternative to U.S. Treasuries. "We think the US exceptionalism is over for the time being."
Over the past 14 years, the S&P 500's gains have been nearly 10 times those of the emerging markets index.
Jitania Kandhari, deputy chief investment officer at Morgan Stanley Investment Management, feels like she "finally has a catalyst." Two years ago, she shifted from U.S. to emerging-market stocks, declaring that the era of emerging markets had arrived.
This time, she's more confident: historical averages suggest a weaker dollar could contribute one-third of emerging-market equity returns. Data compiled by Bloomberg show that while her fund underperformed the U.S. market over the past two years, it has delivered a 17% return this year, beating 97% of its peers.
Which areas are worth watching?
Now, Kandhari is digging deeper for stocks in banking, electrification, healthcare, and defense sectors more tied to local demand and thus less vulnerable to tariff hikes. AQR managing director Chris Doheny is turning his focus to smaller-cap emerging-market companies expected to perform well over the medium to long term.
Data compiled by Bloomberg show that in the week ending May 9, inflows into U.S.-listed ETFs targeting emerging markets and specific countries totaled $1.84 billion, more than double the previous week's figure.
Admittedly, reversals, political turmoil, and localized crises are inherent features of the emerging-market asset class, and this year's rally could still falter. Compared to the U.S. and other developed markets, uneven corporate earnings growth in some developing nations, along with trading costs, has also given some investors pause.
Gabriela Santos, chief market strategist for the Americas at J.P. Morgan Asset Management, noted that so far, the shift from U.S. to emerging markets hasn't been reflected in broader capital flow data, while interest in European assets has.
But if the dollar continues to weaken, "then that second step could spill over to emerging markets in a positive way," she said.
Compared to some larger emerging markets, the U.S. appears constrained in its ability to stimulate the economy as its outstanding debt nears $30 trillion. Countries like India and the Philippines have moved quickly to slash interest rates aggressively, while the Federal Reserve remains cautious about overly aggressive easing to avoid reigniting inflation.
"The fundamentals of major emerging markets are robust, characterized by lower external debt and favorable debt-to-GDP ratios," Franklin Templeton's Tan said, citing Turkey, Saudi Arabia, South Korea, and several Asian nations."This low debt profile is a significant draw, especially when compared to the US."
