Emerging Market Indices Require Special Attention Now, Morgan Stanley Says

Many institutional analysts try to convince investors lately that markets are in an oversold zone on technical parameters, but the truth is that overall sentiment remains bearish and there could be selling on every rise. Global sentiments are still continuing to be negative and the earnings season has not thrown up major positive surprises. Morgan Stanley stands out by forecasting range-bound markets for equities, credit, yields, and the U.S. dollar over the next 12 months. Morgan Stanley analysts in their mid-year equity market outlook note on Wednesday said that Asian and emerging markets are entering the late stages of a bear market, which means the near-term risks are known, but still potent in terms of their ability to aggravate performance of the global risky assets in the coming months. In this respect, Morgan Stanley recently pared India’s growth forecast for FY23 to 7.6% from 7.9%, estimated earlier. It said that a slowdown in global growth, higher commodity prices and risk aversion in global capital markets expose Asia’s third-largest economy to downside risks.

Furthermore, MSCI said last week 88 securities will be added to and 109 more will be purged from its widely followed MSCI ACWI Index after its semi-annual index review. The three largest additions to the emerging markets index will be Saudi Arabia's International Company For Water And Power and China's Orient Overseas and Guangzhou Auto.

Global equities rebounded initially in May, but the rally ran out of steam given the continuing geopolitical escalations in Europe. The U.S. Federal Reserve’s increasingly hawkish tone accelerated the rise of long-term bond yields. The message from central banks to investors is that they are worried about inflation and – more importantly – that they will fight to restore price stability. In this environment, equities fell by 8.1% in April (MSCI AC World index in US dollar terms), marking the largest decline since the 13.7% drop in March 2020 and sending the index back to its lowest since March 2021.

Another element that weighed on investor sentiment was the imposition of tighter restrictions by Chinese authorities in response to the Omicron wave, and the risk of further lockdowns after the mandatory testing campaign in Beijing in late April. This hampered consumption and was seen as a risk to global manufacturing activity.

Against that backdrop, the People's Bank of China (PBoC) announced a widely anticipated cut in its reserve requirement ratio (RRR). The poor short-term economic outlook, and the government's adherence to achievement of its 5.5% GDP growth target for 2022, prompted the Chinese government to double down on a wide plethora of its measures to support economic activity and financial markets. These measures included those affecting digital economy companies, which had suffered from stricter regulation.

As a result, emerging market equities held up better than developed equities in April (-5.7% for the MSCI Emerging Markets index in US dollar terms). However, in some markets, it became clear towards the end of the month that investors were capitulating and preferring to hedge against further falls over repositioning themselves in the market.