Posts here in late 2015 and early 2016 argued for a positive stance on emerging economies and equity markets because 1) narrow money trends in the “E7” large economies had strengthened, signalling a recovery in growth during the first half of 2016, and 2) US money trends, by contrast, had weakened, suggesting reduced upward pressure on US interest rates and the dollar – this was expected to bring relief to China and other countries suffering capital outflows.

E7 economic growth has, indeed, rebounded since end-2015, with money trends suggesting a further pick-up. US / G7 money developments are also now positive. US rates, however, may soon be under renewed upward pressure from firmer economic data and a continued rise in wage growth. This suggests remaining positive on emerging markets but tilting equity market exposure towards “cyclical” markets that benefit disproportionately from stronger global growth while reducing weightings in “interest-rate-sensitive” markets that have correlated positively with US / domestic bond prices historically.

Six-month growth of E7 real (i.e. consumer price-deflated) narrow money began to surge in mid-2015, suggesting stronger economic momentum in spring 2016, allowing for an average nine-month lead. Non-monetary leading indicators confirmed this signal in early 2016. Six-month growth of E7 industrial output rose sharply in May, maintaining a stronger level in June. Real money growth, meanwhile, has risen further, reaching its highest level since 2010 – see first chart.


The increase in E7 real narrow money growth in late 2015 contrasted with a slowdown in the G7, resulting in the E7 / G7 gap turning significantly positive. As noted at the time, emerging equity markets have outperformed developed markets on average historically when the E7 / G7 gap has been positive, underperforming when it has been negative. A rebound in G7 real money growth during the first half of 2016 has narrowed the gap but it remains in favour of emerging equities – second chart.


The rebound in emerging-world economic growth is feeding through to profits. The equity analysts’ earnings revisions ratio  – upgrades minus downgrades expressed as a percentage of the total number of estimates – for constituents of the MSCI emerging markets index has risen to zero, its highest level since 2011. (The average level of the ratio historically has been significantly negative, reflecting analysts’ bias towards over-optimism.) The ratio for the MSCI World developed markets index remains negative but is recovering – third chart.


US economic growth is expected here to speed up significantly in the second half – see previous post. Wage pressures, meanwhile, may increase further. Annual wage growth has tended to rise or fall in recent decades depending on whether the job openings (vacancies) rate has been above or below 3.0% (its average since 1990). The openings rate remains well above this level currently, at 3.8% in June – fourth chart.


The Federal Open Market Committee, therefore, could raise interest rates earlier and by more over the next six to 12 months than markets currently discount. Upward pressure on US rates could boost the dollar and cause capital outflows from emerging markets to pick up again.

The judgement here is that a return to a vicious cycle of capital outflows, currency weakness and equity market underperformance is unlikely because domestic monetary and economic conditions are much more favourable than in 2014-15. A synchronised pick-up in E7 and US economic growth, moreover, could boost commodity prices.

The suggested scenario could favour those markets that have performed better historically when global growth is strengthening (“cyclical” markets) at the expense of those with greater (negative) sensitivity to US / domestic bond yields (“interest-rate-sensitive” markets). Analysis of relative returns since 2005 places Brazil, Hungary, India, Indonesia and Russia in the cyclical grouping, with Chile, Colombia, Malaysia, Philippines and South Africa classified as interest-rate-sensitive. (Other markets have been “averagely” sensitive to the two factors.) Monetary trends, among other considerations, should also be taken into account in assessing the relative attraction of a particular market.