Credit Suisse expects emerging market currencies to perform better in 2016

Emerging market equities and currencies have already priced-in the impact of the forthcoming normalisation of interest rates by the US Federal Reserve, so the worst may almost be past for investors in the asset class, according to analysts at Credit Suisse.

“Currency weakness and declining profit margins have been responsible for contributing the bulk of emerging market equity underperformance in 2015, and, indeed, for most of the past five years.

“However, we are confident that for both these drivers the worst is behind us, thus heralding an improved outlook for the asset class in 2016,” analyst Alexander Redman said in a research note sent to clients entitled “Its darkest just before dawn.”

Redman set a year-end 2016 target for the MSCI Emerging Market index of 960, which offered a potential 15% return when measured in US dollars.

He recommended clients ‘overweight’ China (5% overweight), Korea (10% overweight), India, Mexico, Malaysia (up to 5% overweight from 30% underweight) and Turkey, funded by ‘underweight’ positions on Brazil (15% underweight from benchmark), Russia (50% underweight from 20% underweight), Thailand, Philippines and Poland.

One of the best returns year-to-date globally had been for Russia’s Micex index (32.2%), although upon translation into US dollars its return was reduced to a less stellar 15.6%.

The Swiss broker said it was ‘benchmark’ on Taiwan, South Africa, Indonesia and Chile.

Credit Suisse also expected EM currencies to fare “significantly better” in 2016 compared with the previous year for five reasons.

Among the reasons cited were the fact that the initial hike in a fed tightening cycle usually coincides with a consolidation in the US dollar and the fact falling inflation differentials between emerging and developed markets, which usually leads to strength in emerging market currencies.

Lower dollar speculation as momentum in the dollar trade weighted index slows, better external positions among emerging markets and a heavy discount for global emerging market FX versus global export market share and purchasing power parity were the other factors cited by Redman.