Emerging market stocks edge higher as investors cheer reforms

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Former emerging market pariahs have been among the world’s best-performing stocks this year, as investors bet that reforms in troubled economies such as Argentina and Pakistan will help them put the worst of their problems behind them. of their currency.

Argentina’s Merval index has led Latin American bourses, rising 53 percent in US dollar terms, while Pakistan’s stock gauge is one of the best performing in Asia as markets that until recently were seen as very turbulent, have outperformed their larger and more expensive counterparts.

These so-called frontier markets have been attractive because of their cheap valuations, investors say. In contrast, indices in more established markets such as Mexico and Brazil have fallen in dollar terms as capital has been drawn to rising US AI stocks.

“You have a great absorbing sound from the USA, called [chipmaker] Nvidia,” which has pulled money out of larger emerging markets, said James Johnstone, co-head of the emerging and frontier markets team at Redwheel, an investment manager.

“But what is working well are the markets that have passed the almost existential crisis and carried out the necessary reforms,” ​​he added.

A group of emerging economies, including Sri Lanka and Turkey, “have been through a really tough time” but are now poised for recovery as expensive foreign currency debt and double-digit inflation rates are brought under control, it said. Johnstone.

In Pakistan, the Karachi stock market has risen 30 percent since the start of 2024, more than the stock indices of Taiwan and India. It has almost doubled in dollar terms since June last year, when the country avoided a default by securing a $3 billion loan from the IMF.

“The latest decline is due to investor confidence that Pakistan will get a long-term deal with the IMF after the successful completion of the standby agreement last year,” said Mohammed Sohail, chief executive of Pakistani brokerage Topline Securities.

Even after the recent surge, Pakistani stocks still trade at around 3.7 times earnings, roughly half the historical average of seven, Sohail added.

The biggest contributor to growth came from the banking sector, which enjoyed big gains after the central bank raised its policy rate to above 20 percent to curb runaway inflation, according to a research note from Arif Habib Limited, a Pakistani brokerage. . .

However, foreign inflows into Pakistan’s stocks remain minimal and the turnaround is instead a reaction to a drop in food and fuel inflation, which rose after Russia’s invasion of Ukraine, said Dominic Bokor-Ingram, a senior manager portfolio in emerging and frontier markets in the proud Capital. “We don’t see it as a reform story, but as a recovery from very low levels,” he said.

Some frontier equity markets remained sour in the first half of the year in dollar terms, as currency devaluations have occurred recently. Egypt’s stock market, for example, is down 27 percent this year, hit by the devaluation of the Egyptian pound in March.

Even in the group of countries that have experienced stock market growth, economic conditions remain largely miserable for ordinary people. Inflation is often still high compared to other emerging markets despite sharp interest rate hikes – in Turkey, for example, inflation cooled for the first time in eight months in June but is still 71.6 percent. A number of governments are facing resistance to plans to raise taxes to pay off their debts.

Nairobi’s stock index has risen 44 percent in dollar terms this year as Kenya avoided a looming bond payment default and the shilling rose more than a fifth against the dollar.

But last month, President William Ruto withdrew a finance bill that was part of a plan to meet an IMF bailout after a deadly blow to protests against what were seen as tough tax measures failed.

Pakistan’s finance ministry unveiled a tax-heavy budget last month aimed at boosting revenue and allaying IMF concerns as the country’s shaky ruling coalition looks for a way out of anemic growth, inflation double digits and the increase of public debts.

Argentina’s President Javier Milei has signed the economic measures into law, moving quickly compared to past reform efforts that mired in political opposition, Bokor-Ingram said. “The difference between this time and all the previous times is the speed with which Miley did it.”

Frontier markets and more idiosyncratic large markets such as Argentina have also entered investors’ radars as they try to control exposure to larger emerging markets such as China.

However, despite the promise of reforms in some countries, many investors are aware that returns in EM stocks have generally been poor over the past decade compared to US markets, one emerging market equity manager said. At the end of the day, the manager added, “you’re just operating in a very cyclical asset class.”