EM Strategy Views:Macro exposures amidst a stumble over tantrum fears

Our views in short:

    A sharp bond sell-off has pushed EM assets off their highs n and back towardsearly August levels, with MSCI EM sitting just above our fair-value level of 880.

    Last week, we highlighted that EM EPS have finally started to move higher and,outside fundamentals, our “flow gap” model suggests MSCI EM could hit 945(+2% from current) if foreign flows mean-revert to their long-term trend.However, higher rates pose a valuation threat to EM equity, which trades at itspost-GFC highs of 12.4x P/E (NTM), as a 10bp increase in G-10rates tends tocause a 0.1x decline in the EM equity multiple.

    This week we consider three topical macro factors (China Growth Wavefront, oil,and US rates) and argue that they have been in the driving seat across EM assetsin recent months.

    Over the near term, we maintain our preference for EM sovereign credit andexpect further outperformance of China-sensitive equities (Korea, Taiwan, andBrazil), but a hawkish surprise from the Fed (the market is pricing a 26% hike onSeptember 21), would weigh most on rate-sensitive EM (ASEAN in particular) aswell as BRL, MXN, and TRY in FX.