Investors pile into EM stocks anticipating jump in UST yields

On the last Friday of August, the eyes of investors across the world were glued to the live stream of the Jackson Hole Economic Symposium as Federal Reserve Chairman Jerome Powell delivered a 20-minute speech titled Monetary Policy in the Time of COVID.

Investors listened as Powell displayed typical linguistic skill – telling the world that monetary policy tapering is imminent, but somehow managing to do so in an incredibly dovish way that resulted in Wall Street recording new record highs.

“We have said that we would continue our asset purchases at the current pace until we see substantial further progress toward our maximum employment and price stability goals, measured since last December, when we first articulated this guidance. My view is that the “substantial further progress” test has been met for inflation. There has also been clear progress toward maximum employment,” said Powell.

“At the FOMC’s recent July meeting, I was of the view, as were most participants, that if the economy evolved broadly as anticipated, it could be appropriate to start reducing the pace of asset purchases this year. The intervening month has brought more progress in the form of a strong employment report for July, but also the further spread of the Delta variant. We will be carefully assessing incoming data and the evolving risks. Even after our asset purchases end, our elevated holdings of longer-term securities will continue to support accommodative financial conditions.

“The timing and pace of the coming reduction in asset purchases will not be intended to carry a direct signal regarding the timing of interest rate liftoff, for which we have articulated a different and substantially more stringent test.”

Low interest rates are a powerful sustenance for stock markets, particularly large cap tech which dominates US markets.

So, the immediate Wall Street response (if viewed in isolation) suggested investors absorbed one key message from the speech – rates aren’t rising for some time and tapering if of no concern.

However, data from emerging markets in the days that followed tells a different story.

Huge flows into EM stocks

A note sent to Vanda Research clients this week and seen by Asia Markets highlighted foreign investors bought a total of US$6.9 billion in emerging market stocks during the week that followed Powell’s Jackson Hole speech.

Taiwanese equities were the largest beneficiaries with US$ 3.3 billion, followed by Korea (US$ 1.8 billion) and India (US$ 800 billion).

The Taiwanese inflows were dominated by TSMC (Taiwan Semiconductor Manufacturing Company) (TPE: 2330) which attracted US$ 1.8 billion – the largest inflow of foreign money recorded in many years.

EM stocks
Source: Bloomberg, Vanda Research

Investors, who remain substantially overweight the US, have been prompted by Powell to seek portfolio contingencies.

“Institutional investors have never been this long US equity vs. RoW. The global growth slowdown, Fed tapering, China’s tech crackdown and slow vaccination rates are some of the reasons why institutional investors have cut exposure to the region in favor of US growth stocks,” Vanda’s research note stated.

But the the tide is shifting, and a rise in US treasury yields towards the end of the year – something Powell implied is likely – could see a new form of powerful sustenance fuel a resurgence in Asia markets.

“As the impact of these factors wanes and UST yields rise into year-end, we expect Asian equities to outperform,” Vanda told its clients.

Vanda upgraded its outlook for Asian equities just days prior to the surge in EM inflows and significant gains in developed markets across the Asia region over the past few days, led by a stunning surge in Japan.

It seems to be another very well timed call by the trusted macro research firm.