Equity and bond markets in global overview

The equities uptrend increasingly faltered in the first half of April. This was largely due to the US economic data and subsequent statements from the US Fed, but a serious escalation in the Middle East and oil price increases also played their part. Negative inflation surprises are pushing any key rate cuts in the USA even farther into the future. The new oil price increases are fuelling fears of resurging inflation. Alongside the soft landing scenario that is still favoured by most, increasing attention is also shifting to the possibility of a “no landing” scenario. This would be a situation where the slowdown in growth, the labour market, and inflation would only be marginal and the Fed could thus not easily justify key rate cuts.

Against this backdrop, US bond yields rose significantly recently, and the USD also moved up. Both of these trends are generally negative or at least mean headwinds for shares and bonds in the Emerging Markets. However, the developed equity markets have moved down much more substantially than the share prices in the Emerging Markets up until now. If this is simply a breather after the all-time highs posted in many places or the start of a significant correction is hard to predict at this time, as the tense situation between Israel and Iran is a source of considerable added uncertainty.

Positive March, then April showers

February’s good sentiment on the equity markets continued almost seamlessly into March. The stock indices posted gains nearly everywhere. With an increase of just under 2%, the Emerging Markets lagged somewhat behind the developed equity markets (plus 3%), each calculated in US dollars. The markets had done well in dealing with stronger growth, more robust labour markets, and more persistent inflation rates in the USA up until then. But new negative inflation surprises gave rise to more and more doubts about the previously favoured soft landing economic and key rate scenarios. Possible interest rate cuts were priced out or moved farther back in terms of timing, given that firmer commodity prices (industrial metals, oil) are also not good for the inflation outlook. The “no landing” scenario, meaning a continued robust economy with excessively high inflation and excessively tight labour market, is still a minority view but is getting more traction. US bond yields for long terms rose significantly, by 0.30% to 0.40%, in the first half of April against this backdrop. Another increase of this extent would bring them back to their highs from last year.

This is all the more remarkable considering that the situation in the Middle East escalated significantly in the middle of April, especially between Israel and Iran. “Normally” in such a crisis situation, the US dollar, gold, and US government bonds should see higher demand among investors as safe havens. While the dollar and gold continued to strengthen, US government bonds remained under selling pressure. The equity markets also lost ground in this phase, though the developed markets corrected much more substantially than the Emerging Markets this time around.

Further escalations in the Middle East could have a negative impact on economies and financial markets above all through higher oil prices. But there are a number of signs that neither side is currently interested in the situation worsening further, let alone spiralling out of control. Thus, the reactions in the financial markets have been moderate up to now.

Expansive US fiscal policy as a global risk

However, the US government’s very loose spending policy could cause further upside pressure on bond yields and inflation expectations. The US budget deficit is expected to come in at between 6% and 7% this year, and will remain high in the coming years. In the past, this was only seen in times of crisis or during recessions. A few days ago, the International Monetary Fund (IMF) warned that sustained high budget deficits in the USA harbour substantial risks for the US economy and world economy. On the one hand, the US economy is surprisingly strong. But this also reflects a government spending policy that is not sustainable over the long term. Washington’s additional spending, the report said, harbours the risk of a resurgence in inflation and of undermining the long-term budgetary and financial stability of the entire world by pushing up financing costs around the world.

The IMF is also worried about China’s rapidly rising debt and the growth problems there. The fear: Beijing could try to solve the problems via new export offensives, which could trigger new tensions in global trade. Time will tell whether these worries are justified. Because China has been trying for some time now to move away from an export-driven growth model. And the most recent Chinese quarterly figures were surprisingly good, with economic output expanding by around 5.3% in the first quarter of 2024. These data likely came too late for the IMF report, and one good quarter of course does not yet constitute a trend. But it shows that China may have passed the low point. And that would be good news, including for many emerging countries and their financial markets.

Attractive long-term equity valuations

Considering the long-term valuation levels, Emerging Market equities are trading at a significant valuation discount over the developed markets in general. Part of this reflects the higher risks (such as price volatility, liquidity, political and legal conditions). Another part can be attributed to the currently high valuation of US equities. But aside from this, a substantial portion does consist of a genuine discount. This discount should decline over the long term, as growth in the Emerging Markets will continue to be higher than in the industrialised countries. This would mean above-average price performance in the Emerging Markets over the coming 5 to 10 years. Granted, investors have been waiting for such a trend in vain for some time, and no one can guarantee that it will come to pass. But the chances are rather good, all the more so considering that the earnings growth of many companies in the Emerging Markets may increase and very well surprise on the upside in the coming quarters and years.

Positive outlook for EM bonds still intact

The medium- and long-term outlook for Emerging Market bonds is also still positive. However, the fact that yields on local-currency bonds are at historically attractive levels and USD-denominated EM bonds offer attractive absolute yields provides a good basis for solid returns. We see especially good potential for EM hard-currency bonds this year. Naturally, this does not apply equally for all EM countries and issuers, and – as always – good selection was and continues to be vital for investors here.