The economic theories that have typically influenced the performance of emerging market shares have been usurped by other events over the past year.
Emerging market performance was traditionally viewed in part as a function of US interest rates. This has happened for two reasons. If US rates are low, investors take more risk. As the yields available on cash, government bonds and safe-haven equities in their own markets become less attractive, they search for higher yields in higher-risk areas such as emerging markets.
Economic theory also suggests that low interest rates should be positive for global economic growth. This is particularly beneficial from an emerging market perspective: it improves liquidity, and the commodity prices that underpin many developing economies tend to move higher in such scenarios.
Thus, according to conventional market logic, the gradual increases in US – and more recently UK – interest rates should mean emerging markets start to underperform.
As rates rise, so do the yields on lower-risk assets such as government bonds, meaning there is less incentive to invest in emerging markets.
Higher interest rates have also been bad news for emerging markets in the past, because many corporations and countries must borrow in dollars or other developed market currencies. As rising rates push up the value of those currencies, emerging borrowers need more money than previously to repay the debt, and that leaves less free cash for investment, dividends, and so on.
These implications were highlighted in the winter of 2014 when investors were gripped with anxiety over US interest rates rising. Risk assets, including emerging market shares and bonds, bore the brunt of the sell-off.
Yet despite a seeming litany of headwinds, emerging market equities have been one of the stronger performing markets of 2018, gaining 0.72 per cent in the three months to the end of March – a period when the US, UK and major European markets were all in the red.
Austin Forey, a managing director at JPMorgan Asset Management, running around £2bn across a number of emerging market equity funds, believes he has the answer to this anomaly.
He notes that while US interest rates have been rising, the dollar has actually been falling. Mr Forey says the negative impact of interest rates hikes only happens when the dollar is rising.
Donald Trump’s policy of tax cuts could well ensure the dollar remains subdued, as it increases the budget deficit.
On top of this, Mr Forey adds that emerging market economies are now less reliant on short-term funding from overseas investors than was the case in the past. He says this is because of the structural changes in these economies.
Many emerging market countries now have substantial domestic savings, so debt issued in those economies can effectively be funded by the local population, rather than from overseas markets.
This contrasts with developed markets, where consumer savings ratios are much lower.