Emerging markets punished by the strong US dollar

The strong US dollar is pushing more and more capital into Europe and out of the US and emerging markets.

The latest data on capital flows show big outflows from emerging markets, both from fixed income funds and from equities funds.

Emerging markets outflows

Emerging markets saw outflows again. Source: RBS

The negative turnaround for emerging markets fixed income assets in the week that ended on March 11 was very noticeable, with outflows totalling 0.25% of assets under management (AUM), compared with 0.28% of AUM of inflows in the previous week, data from RBS show.

Flows into hard currency emerging markets debt funds saw a sharp drop, to just 0.02% of AUM from the previous week’s 0.91% of AUM worth of inflows, while local currency funds saw outflows of 0.80% of AUM.

“In our view, this turnaround is primarily driven by an increase in global volatility and a steep rise in US yields following the better-than-expected US payroll release,” said Anna Tokar, emerging markets analyst at RBS.

Emerging markets equity funds also saw significant outflows of 0.30% of AUM, compared with four weeks in a row of inflows previously.

In absolute terms, the outflows from emerging markets equity funds totalled $3.6 billion and were the biggest since December last year, according to data from Bank of America Merrill Lynch.

With the US dollar index on course for a gain of nearly 14% in the first quarter, US equities saw the biggest outflows last week, of $7.5 billion. Money went out of US equities in nine of the past 10 weeks.

Japanese stocks saw their largest inflows since October last year, of $2.5 billion, while European equities again saw the biggest inflows, worth $5.2 billion. It was the ninth straight week of inflows for European stocks.

Year to date, the redemptions from US equity funds were $47 billion while the inflows into European equity funds amount to $36 billion.

Inflows into European assets are “strongly mimicking inflows to Japan after the Bank of Japan quantitative easing announced in April 2013,” Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, said.

However, in terms of valuation US equities remain more expensive than most. The 12-month forward PE ratio for US stocks is 17; for European stocks it is 15.2 and for Japanese stocks it is 14.7.

Emerging markets look cheap by comparison, trading on a PE of 11.3. Russia is the cheapest of the asset class, on a 4.8 PE ratio, but it is too risky for political reasons.

Chinese stocks, on a PE of 9.8 and Korean equities on a PE of 9.7 look particularly attractive, but the current environment is risk adverse.

Investors are moving out of other risky assets too. They left high-yield debt funds, which saw $600 million pouring out, their first outflows in seven weeks.

Investment grade debt has continued to roll, recording inflows for the 64th week in a row. Inflows into investment grade debt were worth $3.6 billion in the week that ended on March 11.

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