We maintain a pro-risk allocation in our EM equities model portfolio focused on benign drivers: above-trend global GDP growth, loose monetary policy, and the easing of major market risk (COVID-19 vaccine advances) driving risk premium lower. All of these should support important rotations within EM toward Value / Cyclical sectors and Ex-North Asia allocation.

Our allocation toward cyclical sectors remains, with a targeted focus on investment themes related to reopening and reflation trades. Our key asset allocation calls are (1) OW Brazil, Indonesia, Mexico, Russia, Taiwan, and Thailand; (2) OW Cons. Discretionary, Financial, Industrials, and Materials;(3) UW Argentina, Colombia, Malaysia, Peru, and Saudi Arabia & MENA; and (4) UW Cons. Staples, Healthcare, and Utilities.

As recoveries have advanced and inflation has surprised to the upside, DM central banks are proceeding with plans to scale back their balance sheet policies. Our economists maintain their view of a tapering in Fed’s asset purchases to begin in November or December. We think this time around, EM macro fundamentals are healthier versus 2013. Reduced external vulnerability and persistent slack in EMs differentiate economic conditions from the 2013 taper episode, amid more supportive positioning on EM equities and relative EM/DM growth momentum

In any case, a taper in the Fed’s asset purchases would eventually lead to higher US yields, and hence we try to assess the impact of higher US treasury yields on EM equities. We use three quant approaches to measure the impact of rising US yields on EM equities: (1) correlation of EM equities with US 10-year treasury yields; (2) quantify EM equities performance during periods where the US 10-year treasury yield increased by more than 50bps; and (3) compare relative attractiveness of EM equities to bonds given low bond yields globally and higher scrutiny to sovereign risk.

Crossing the three approaches above reveals a preference for CEEMEA and North Asia and cyclical sectors. These markets have positive returns in a rising US yields environment, higher than 10% correlation to 10-year US treasury yields, and EY-BY greater than EM. Rising US yields present a case to be positioned on: (1) cyclical sectors within EM, particularly Energy, Materials, Industrials, and Financials; and (2) Russia, Hungary, Czech Republic, Poland, Greece and Saudi Arabia in CEEMEA, Taiwan, Thailand, South Korea, and China in Asia, and Chile in LatAm.