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While the relative strength of the US and European economies continues to support their equity markets, Nicola Dransfield underlines the investment case for emerging markets backed by strong global numbers and an improving inflation outlook.

Our key messages this week are:

Europe reigns 

Last week, the positive market momentum of previous weeks continued across Europe and the US. This was supported by a more stable political outlook in Europe following Emmanuel Macron’s win in the final round of the French presidential election. The result fed into equity markets as the DAX and CAC 40 registered positive moves in the week. In the US, equities also continued to move higher with the technology-heavy NASDAQ touching record highs as tech companies reported impressive earnings growth. We maintain a positive outlook for equities, particularly in Japan and Europe.


UK rates stay put

There was a focus on the Bank of England as it held interest rates at an expected 0.25%. However, the near term outlook for GDP growth was revised downwards – and inflation upwards – and as a result, sterling weakened slightly.

Strong macro data from Italy and France, particularly industrial production and sentiment surveys, again supported our positive outlook for European equities.

In the emerging markets, Brazil reported an inflation rate of just 4%, the lowest rate since 2007. This is despite several interest rate cuts over the past six months that have reduced the policy rate to 11.15 from 14.15% in October last year. This highlights how high local yields are in many emerging markets compared to developed markets, one of the reasons we like emerging market debt.


The case for emerging market debt

Our emerging market local currency debt has broadly generated returns in excess of lower-risk US treasuries, as well as the relatively more risky US high yield bonds (see below) over the year to date.

So what are the main drivers of performance in 2017?

Firstly, global economic data continues to improve with manufacturing purchasing managers’ indices (PMIs) strengthening and trade activity on the rise. We believe this is positive for both developed and emerging markets. 

Secondly, we think the tensions between the US and emerging markets have lessened in recent weeks. While campaigning to become US president, Donald Trump proposed a number of policies that would have been negative for emerging markets, such as protectionist trade measures. Since then however, his willingness and - in some cases - ability to implement such policies have come into question and as a result the concerns regarding emerging markets have been somewhat alleviated.

In line with our investment principles, we are value-focused investors and continue to see emerging market debt as an attractive return-generating opportunity

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