The big rebound for emerging markets

Talk of 'tapering' by the US Federal Reserve has hit emerging market stocks hard. But despite the panic, the long-term outlook hasn't changed, says Lars Henriksson. And if history is anything to go by, markets should soon bounce back.

Emerging markets have taken a big hit recently. It's all because of talk about 'tapering'. At the latest Federal Reserve meeting on 20 June, the US central bank signalled it could start to wind down assets purchased in the second half of 2013, and end purchases by mid-2014.

Shareholders didn't like it one bit, and emerging market stocks fell extra hard. This raises a big question for us: what next?

Well, despite the panic, I don't think the long-term outlook has changed at all. Today I want to put you at ease, and tell you why I still like my favourite markets in Southeast Asia.

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Since the financial crisis, the world's central bankers have been hosing the markets with liquidity (quantitative easing). This has resulted in some unusual outcomes, summarised by Bank of America Merrill Lynch as follows:

$12trn of financial asset purchases by the big five central banks 520 central bank rate cuts $33trn of fiscal and monetary stimulus (equivalent to 46% of the world economy) The lowest US government bond yields in 220 years

Concerns about tapering triggered a stampede for bond and credit investors. A sense of unease from investors can be seen in the amount of investments flowing out of funds.

Fixed income funds recorded a net outflow of $20bn last week. Far more worrisome is that US Treasury bonds are on course for their worst year since 1978; municipal bonds since 1989; and investment grade bonds since 1973. Emerging bonds reported their largest weekly outflows in history of $7.5bn.

Emerging market equity funds have been hit hard too - losing $19.9bn in June. That's more than in January 2008 when outflows reached $18.7bn. Most of the selling comes from passive investors' (eg exchange traded funds, ETFs) in the US or Europe.

One thing that should put us at ease, though, is that over the last decade emerging market funds have recorded two big sell-offs (in 2008 and 2010) and both were followed by strong inflows the following years.

And I believe we are about to see a similar rebound again.

Four investment implications of the big sell-off

Sentiment towards emerging market equities is close to rock bottom

Emerging market bonds could see further sell-offs

To recap, liquidity inflows pressured central banks to cut rates to limit currency appreciation, and low interest fuelled higher asset prices, particularly property, triggering various cooling measures. Now there is scope to cut/hold interest rates, underpinned by weaker commodity prices which are major components in calculating inflation in Asia.

A switch from bonds to equities is on the cards

The fundamentals will matter again

I remain bullish on Asian equities, particularly in the Association of Southeast Asian Nations (ASEAN), as these economies are going through investment-led growth linked to the AFTA 2015 free trade agreement an early EU-type of economic integration allowing the ten member countries greater integration, specialisation and competitiveness.

This is something that has never been seen before in this region. It's going to have a monumental impact on all ten countries involved. I am convinced that, despite the recent sell-off, there are big, big gains to be made here.

Lars is our resident emerging markets expert, with 17 years of 'on the ground' experience hunting down profit opportunities in Asia. Lars spent ten years living in Malaysia and Thailand, seeking out strategic opportunities, before moving to London to manage the Oracle Asia Absolute Fund. In short, Lars has real knowledge of where the opportunities in Asia are. Sign up to his free newsletter, The New World, here.