Will global equities extend the recent rally?

February 15, 2019 12:28
If the Fed continues its current pace of shrinking its balance sheet, emerging markets may feel liquidity pressure again soon. Photo: Reuters

Hong Kong, emerging markets and the US have all seen equity markets moving up in the New Year, with the benchmark indexes gaining more than 9 percent.

Stock markets have reversed the sluggish performance of the fourth quarter of last year and regained momentum, thanks to improving prospects of a US-China trade deal.

Around US$7 billion net was pulled out of emerging market equities from US-listed ETFs as of the end of June last year, marking the second highest capital outflow in record.

But things began to change from November last year. Investors started to deploy capital back to emerging markets at an unprecedented pace. Through ETFs, a net US$7.36 billion flew into emerging market equities as of January this year, setting a new high since 2014.

Investors are returning to emerging market assets for several reasons.

The easing tension surrounding US-China trade war is one of them. Also, the Federal Reserve has slowed its pace in hiking interest rates, leading to a decline in US treasury yield.

But will capital continue to flow into emerging markets? A few things could stop this trend.

First, the dollar index has not fallen dramatically despite Fed’s dovish stance. It has, in fact, staged a rally in recent sessions and hit above 97. Sustained dollar strength will weigh on emerging markets including Hong Kong.

Second, investors might change their mind if global economic growth continues to deteriorate.

Third, if the Fed continues its current pace of shrinking its balance sheet, emerging markets may feel liquidity pressure again soon.

Meanwhile, we have not seen fund inflows into US equities despite their recent strength.

Quite the reverse, ETFs drained a net US$26.5 billion from US equities in the ten weeks up to February 8.

Capital flow has apparently decoupled from the strong rally in last month or so.

That means investors are still staying away from US market, although the main US stock indices have returned above the 200-day moving average.

In fact, money market funds are hovering above a high of US$3.05 trillion in last few months. That suggests that US investors are still very cautious and keeping cash in money market funds.

Given the rapid inflow into emerging equities, it has become the most crowded trade at the moment, but the situation may not last for long.

This article appeared in the Hong Kong Economic Journal on Feb 14

Translation by Julie Zhu

[Chinese version 中文版]

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Hong Kong Economic Journal chief economist and strategist