No longer overbought, still advantaged; Emerging Markets

Emerging Markets (EM) Structural Outlook:

• Analysts remain structurally bullish on EM equities and fixed income based on three core pillars established in early 2025:
  • A secular downtrend in the US dollar is expected to continue.
  • EM asset prices remain significantly cheaper than developed market valuations.
  • Global fundamentals are improving, despite a recent tactical reduction in exposure due to geopolitical shocks.

Iran Conflict Impact Assessment:

• The conflict in Iran is currently treated as a temporary disruption rather than a structural shift in the global order.
• Critical Timeline: April is identified as a pivotal month; if shortages persist beyond this period, the outlook may shift from temporary to secular.
• Pessimistic Scenario (Conflict >1 Month):
  • Likely to trigger higher global inflation, lower global growth, and a stronger US dollar (as an energy-exporting currency).
  • Would disproportionately hurt energy-importing EMs (e.g., India, South Africa, Chile) and increase pressure on their currencies.
  • Could force a structural re-rating of the dollar as a risk-off asset.
• Optimistic Scenario (Conflict Eases Soon):
  • Benefits energy-importing economies (India, Turkey, South Africa) via stabilizing energy prices.
  • Reinforces the baseline bullish case for EM, with inflows likely returning to China and other growth assets.

Country-Specific Investment Views:

• Brazil:
  • Identified as the primary beneficiary of current flows within Latin America due to its status as a net energy exporter.
  • Positive Drivers:
    • High oil prices improve fiscal revenues and support growth.
    • Central Bank initiated an easing cycle last week (March 2026) with expectations for further rate cuts.
    • Strong currency position relative to energy-importing peers.
  • Risks:
    • High oil prices pose inflation risks; the government is actively trying to shield consumers from pass-through effects.
    • Fiscal stimulus measures required to manage inflation could be scrutinized by voters ahead of the October election.
  • Electoral Context:
    • October 2026 elections are a key theme; President Lula's popularity is sensitive to inflation and purchasing power.
    • Early April is a deadline for executive officials to resign if seeking other executive posts; mid-August is the candidate finalization deadline.
    • Corruption investigations remain a potential vote-shifting variable.
• Argentina:
  • Described as an "off-index" bet (not yet part of MSCI-EM) with high potential if reforms continue.
  • Conditions for Re-entry:
    • Requires significant relaxation of capital controls and a full "freeing up" of the capital account.
    • MSCI inclusion process (consultation to announcement) is estimated to take over a year post-eligibility.
  • Equity Thesis:
    • Government efforts to adjust the economy are viewed positively; potential for equity price appreciation if reforms materialize and a congressional majority is secured.
• China:
  • Equities: Driven by domestic tech underperformance and weak domestic demand, though signs of improvement are emerging.
  • Currency: Viewed as undervalued and resilient; expected to strengthen against European and Asian currencies in both optimistic and pessimistic war scenarios due to large sovereign reserves.
  • Resilience: Can withstand energy price pressure better than other Asian peers due to buffer capacity.
• Mexico:
  • Treated as market-weight; performance is highly correlated with the US economy and subject to uncertainty regarding USMCA negotiations.

Regional Flow Dynamics (Latin America):

• Allocation Status: Investors remain under-allocated to LATAM, with participation in the MSCI-EM index historically low.
• Trend Shift: Inflows into the region have accelerated since late 2025/early 2026, driven by:
  • A weakening US dollar facilitating diversification.
  • Geopolitical demand for commodities, positioning LATAM as a critical supplier.
• Divergence: Mexico is more US-tied, whereas Brazil and Argentina are the primary recipients of commodity-driven inflows.

Forward-Looking Themes & Risks:

• Key Themes to Monitor:
  • AI and Resources: AI investment cycles will drive demand for resources and energy, favoring commodity-exporting EMs.
  • Political Volatility: Upcoming elections in Colombia, Peru (H1 2026), Hungary, and Brazil (October 2026) may alter policy mixes.
  • US-China Relations: The rescheduled Trump-Xi meeting (postponed due to Iran) is expected to set the global trade agenda for the coming year.
• Top 3 Risks for LATAM:
  • Oil Shock: Prolonged high energy prices impacting inflation and fiscal stability.
  • Dollar Strength: A reversal in the dollar's downtrend could halt inflows.
  • Electoral Outcomes: Risks of policy reversals or increased volatility in Colombia, Peru, and Brazil.

Market Sentiment Correction:

• Investor sentiment was potentially over-optimistic prior to the Iran conflict, leaving EMs overbought.
• Recent market faltering in March has corrected this, making valuations appear more attractive for a structural entry.