A weaker dollar has lent support to emerging market equities over the past few months, but the currency is set to move, he believes.
“The US dollar has sold off recently and we may see a stabilisation in the short term,” Franklin told FSA.
A second concern is the US Federal Reserve, which has had “a relatively patient and a dovish stance when it comes to monetary policy”, he said.
“In the near term, we don’t necessarily think that it will turn 180 degrees, but heading into the second half, [the monetary policy direction] will be data dependent. If the US inflation data does solidify, the market may need to price in more normalised monetary policy from the US.”
The outlook on the EM markets remains uncertain, he said.
“Many emerging market economies still have structural problems that cannot be resolved in the near term,” he said.
For example, there is a high level of household debt in places such as Southeast Asia, while in Brazil, there are fiscal [issues] and a political situation which is very unstable, he said.
“The Brazilian economy is going through a deep recession at this point in time, and the same for Russia as well. So structurally, a lot of emerging markets have major challenges to work through even if you are constructive on commodity prices and oil prices.
“The recent sharp rebound in commodity prices, namely iron ore, may not have a fundamentally sustainable driver. We are concerned that we could see some softening of commodity prices, like iron ore and steel prices in China over the next one or two quarters, which then potentially reverse sentiment towards emerging markets.”
China risk is another concern for emerging markets, he said.
“You find lots of people talking positively about emerging markets, but at the same time they are very worried about China. I don’t think you can be positive on emerging markets but negative on China at the same time. I think it’s either or.”
Concerns over China’s corporate debt risks are increasing amid an economic slowdown. GDP rose 6.7% year-over-year in the first quarter, the slowest since 2009. The IMF in April said that loans at risk in China make up 15.5% of total bank loans, or $1.3trn. The country’s corporate bond defaults have significantly increased year-to-date, as the government started to normalise the pricing of bonds issued by state-owned enterprises.
“We would continue to adopt a relatively cautious stance on the Chinese market,” he added.
Franklin’s views tend to run in contrast to some other analysts. For example, Citi Research has has recently moved to overweight emerging market equities from underweight. Falcon Private Bank believes that sentiment has turned in favour of emerging markets. Old Mutual Global Investors said it was overweight in selective emerging market local currency bonds after a strong Q1 perrformance.
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Year-to-date, the MSCI Emerging Markets index has outperformed the FTSE Developed index, according to FE Analytics.
