Iran conflict puts the emerging-markets revival to the test

[NEW YORK] THE war in Iran has dealt a blow to one of Wall Street’s favorite trades – emerging markets.

Their conviction rests on what investors see as the main drivers behind the emerging-markets rally: a push to diversify from US assets, attractive valuations and solid economic growth. Many believe those themes will reassert themselves once the geopolitical shock fades, and fund flows suggest investors are taking advantage of the dip in prices to buy more securities.

Investors added US$12.6 billion to emerging-market stocks and bonds in the week through Wednesday, according to a Bank of America report, citing EPFR Global data.

“We’re waiting for more clarity,” said Nick Eisinger, the head of emerging-markets sovereign credit strategy at JPMorgan Asset Management. “We like the fundamental story across a lot of emerging markets, but unfortunately the fundamental stories don’t really count for very much right now, so we need this shot to pass.”

Still, the risks are mounting, with Brent crude surging past US$90 a barrel and conflict across the Middle East intensifying. The worry is that soaring oil prices will pressure economic growth in countries that rely on imports. As well, a stronger US dollar – which has re-emerged as the haven trade of choice – tends to tighten financial conditions and erode returns for emerging-market investors.

JPMorgan Chase cut its recommendations on emerging-market assets three times in the past week, with uncertainty clouding the outlook for the asset class. The bank’s strategists slashed bullish calls to marketweight on foreign exchange and local rates, and moved to tactical underweight positions on sovereign and corporate dollar bonds. BLOOMBERG