A weak US could hit recovery of emerging markets, Morgan Stanley says

While Morgan Stanley has upgraded its views for stocks in emerging economies, the bank warns that a weaker U.S. could still limit the potential comeback for some of those emerging markets.

“Emerging markets have, both in terms of magnitude and duration, seen a pretty significant correction. And we feel that the conditions are now broadly coming into place that will suggest that these markets begin to outperform, particularly relative to the U.S.,” Gokul Laroia, Morgan Stanley’s co-head of global equities and co-CEO for Asia Pacific, told CNBC’s “Squawk Box” on Tuesday.

“What I am not entirely convinced of is whether or not we see absolute outperformance in the context of a declining U.S., that hasn’t really happened too many times before and it’s not obvious to me that it can happen,” he added.

In a Sunday report, Morgan Stanley upgraded stocks in emerging economies from “underweight” to “overweight” for 2019.

The investment bank said it expects shares in emerging markets to do better than their American counterparts. That’s a turnaround for emerging markets, which have fallen out of favor this year due to a spike in U.S. Treasury yields, strengthening greenback and a scale back in the Federal Reserve’s balance sheet.

Laroia said a lot of money that goes into buying assets in emerging markets come from the U.S. — and a slowdown in economic activity stateside could drag down those markets.

The money flow in and out of the U.S. was responsible for the volatility seen in emerging markets this year. When the greenback appreciated and bond yields rose, investors withdrew from emerging markets and bought more assets in the U.S. As a result, the MSCI Emerging Markets Index — which measures stocks in 24 economies — has fallen by around 16 percent so far this year.

But the strength in the U.S. dollar is likely to end and Treasury yields are expected to trend down, the bank predicted. “On a relative basis,” Laroia said, that will allow stocks in emerging markets to perform better than U.S. equities in earnings and growth.

In Asia, the countries likely to benefit from those developments are Thailand, Indonesia and India, Morgan Stanley said.

In particular, a weaker U.S. dollar would make oil purchases and debt servicing more manageable for Indonesia and India, noted Laroia. However, upcoming elections in those countries may cause volatility, he added.

“I think we will see greater volatility as we approach these elections and that’s going to start playing out, certainly in the case for India, over the next few weeks,” Laroia said.

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