A plurality of institutional investors gave bullish bets on emerging markets the dubious distinction of being the “most crowded trade” in global financial markets, according to Bank of America Merrill Lynch’s February fund manager survey, released Tuesday.
This marks the first time in the history of the survey in which “long emerging markets” was labeled the most crowded trade. But conviction isn’t running high.
Just 18% of investors surveyed agreed that emerging markets are overbought, the smallest plurality garnered by a “most-crowded trade” designee in the survey’s history, according to Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch.
Meanwhile, survey respondents had voted “short EM,” as the third most crowded trade just last month, a reversal that reflects uncertainty as to the wisdom of investing in lesser developed countries.
Year-to-date, emerging markets stocks have risen 8.6%, as measured by the iShares MSCI Emerging Markets ETF
Just behind emerging markets, 17% of fund managers surveyed said the most crowded trade was “long US dollar,” while 14% said it was ‘long FAANG+BAT stocks’, an acronym that stands for fast-growing tech firms Facebook Inc.
Tim Hayes, chief global investment strategist with Ned Davis Research agreed with the cautious optimism toward emerging markets displayed by the survey results, writing in a recent note to clients that emerging markets are the only region of seven (including the U.S. Canada, U.K., Japan, Asia excluding Japan and Europe excluding the U.K.) for which he recommends an overweight allocation.
“After emerging markets started diverging lower early last year, they became increasingly cheap versus developed markets,” Hayes wrote. He added that with the U.S. dollar expensive compared with historical levels, there’s reason to believe that it will decline from here, which would be a positive for emerging market stocks.
“A weaker dollar definitely supports the longer term bull thesis on emerging markets,” Mat Klody chief investment officer at Keebeck Wealth Management told MarketWatch. “We look at these investments in local currency terms and thus in its simplest form, a weaker dollar and stronger emerging currencies mean those emerging-market investments are worth more in dollar terms.”
Perhaps the most important variable for whether emerging markets will pan out for investors is how much the Chinese government does to stimulate its bruised economy. Guarav Sarolya, director of global macro strategy at Oxford Economics wrote in a Tuesday research note that the firm’s model suggests a “modest overweight” for emerging market stocks, with the dominant factor in that determination the belief that the Chinese economy is set to stage a recovery.
“Chinese equities have some positive developments in the making,” Sarolya wrote. “In January, next-12-month forward earnings-per-share growth rose the most since January 2018, in a sign that optimism is returning…If more policy easing is implemented, as our China team is expecting, we would expect [Chinese stocks] to get a further boost.”
But Brian McCarthy, a China-focused macro strategist at independent research firm Macrolens, was skeptical that significant stimulus is on the way, arguing in a Monday note to clients that as of yet, “there remains no sign of meaningful credit stimulus.”
The People’s Bank of China has cut reserve requirements for banks to encourage lending to small, private firms, while the government has cut taxes on businesses and individuals to spur demand. But PBOC has refrained from cutting its benchmark interest rate, nor has there been evidence of the growth in the money supply that typically accompanies efforts to spur local-government infrastructure projects with subsidized state lending, McCarthy said.
McCarthy predicts there won’t be such stimulus forthcoming, given the desire of Chinese policy makers to rein in economywide debt levels, as evidenced by reports that the Chinese government has declined to bail out China Minsheng Investment Group Corp. or Wintime Energy Co., two large Chinese borrowers that recently missed bond payments to investors.
“If policy makers are on the cusp of an aggressive credit stimulus, it makes zero sense not to bail these guys out,” he wrote. “All they need to do is tell a state-owned bank to ‘take one for the team’ and roll this thing over. Why make any impending stimulus more difficult by allowing a massive default to unfold right into a stimulus launch?”