Brazil has company. From Sao Paulo to Mumbai, investors are regaining their faith in emerging markets this year.
It’s a big shift from 2013, when investment in those markets dried up because of worries about their slowing economic growth. It got so tough that five big developing markets – Brazil, South Africa, India, Indonesia and Turkey – were dubbed the “Fragile Five” by analysts at Morgan Stanley.
Now, those countries are much more appealing to investors. Some have taken actions to strengthen their economies. Others have gone through political changes that have bolstered investor confidence. At the same time, slower growth in the U.S. has made investing overseas more alluring.
“These countries have done some homework to reduce their fragilities,” says Jorge Mariscal, chief investment officer for emerging markets at UBS Wealth Management. “They have helped themselves a bit.”
The “Fragile Five” raised interest rates to draw investors’ cash back into their countries. For example, India lifted its rate from 7.25 percent in September to 8 percent in March; Brazil hiked rates from 7.5 percent in May of last year to their current level of 11 percent.
Higher interest rates are appealing to investors in the U.S., where the Federal Reserve has held its benchmark lending rate at close to zero for more than five years, and where bond yields remain low.
In India, the government has also raised duties on gold. The metal is India’s second-biggest import behind oil, and purchases have soared in recent years as incomes have risen there. The increased buying has sped the flow of money out of the country, and weakened its currency.
Politics are also playing a role.
Last month, Narendra Modi and the Hindu nationalist Bharatiya Janata Party notched the most decisive Indian election victory in three decades. Modi marketed himself as a leader capable of shaking the nation from its economic slumber, and his clear win should allow him to reform the economy.
In Brazil, stocks have rallied after polls were released that showed opponents of Brazilian President Dilma Rousseff gaining enough ground to have a chance of forcing a runoff in elections scheduled for October. Her opponents, Aecio Neves and Eduardo Campos, are believed to favor less government involvement in the economy.
Developing economies should also benefit as global growth, led by an improving U.S. economy, begins to pick up later in the year, says Mauro Ratto, head of emerging markets at Pioneer Investments, a fund manager.
The shifts are reflected in the financial markets. Recent gains in the U.S. stock market are smaller than those in emerging markets.
The Standard & Poor’s 500 index has climbed 12 percent since closing at its year-low on Feb. 3. The MSCI India, a broad index of Indian stocks, has surged 30 percent over the same period. Turkish stocks have jumped 44 percent and Brazilian stocks are up 26 percent.
Emerging markets have benefited from the Fed’s easy-money policies. Those policies, with their low interest rates, have prompted investors to hunt for higher rates of return overseas.
Last year, however, when the Fed started to outline its plan for reducing stimulus and raising rates, investors began pulling their money out of emerging markets. That caused their currencies, as well as their stock and bond markets, to plummet.
The MSCI Emerging Markets index, which measures 800 securities across 21 markets, fell almost 10 percent from the start of May to the end of June, and ended the year down almost 5 percent. The Turkish lira dropped almost 11 percent in five months from the start of September to the end of January 2014.
This year, growth in the U.S. has disappointed. Treasury yields have fallen instead of rising, as most analysts predicted. As a result, emerging economies with higher growth are more attractive. Low interest rates also make it more lucrative for investors to borrow in the U.S. and invest in overseas economies that offer higher returns.
“Clearly, the most important driver year-to-date has been the global financial conditions,” says Gerardo Rodriguez, a senior investment strategist for BlackRock’s emerging markets group.
The Brazilian stock market may also get a boost if its team, the favorite to win the World Cup, lifts the trophy at the end of the tournament. Analysts at Goldman Sachs calculate that, on average, a victorious country’s stock market outperforms the global market by 3.5 percent in the first month after the win.
Others are more skeptical of this year’s gains in emerging stock markets.
Andres Garcia-Amaya, a global market strategist for J.P. Morgan Funds, says the comeback in emerging markets is driven by market-specific factors, not improvements in the outlook for economies, and is unlikely to last long. The markets are bouncing back because investors had become too negative, too quickly. Now, they are scrambling to get back in.
The spotlight on Brazil has also highlighted potentially damaging rifts in the country. Subway workers have been on strike, demanding higher pay and improved benefits. Teachers remain on strike in Rio de Janeiro and routinely block streets with rallies. Police in several cities have also gone on strike, but are back at work.
Going forward, investors should be more selective when investing in emerging markets, says Garcia-Amaya.
“The message for investors is, don’t treat (emerging markets) as one,” he says. “It is very important to do your homework at the country level.”