JPMorgan: Why emerging market stocks won’t outperform this year

World currencies

Blame the U.S. dollar, JPMorgan said, advising staying neutral between emerging and developed market equities.

While it said it expected global equities to rebound from recent weakness, JPMorgan added it doesn’t expect emerging markets to be clear outperformers as in the previous two years.

The U.S. dollar is a key factor, JPMorgan said in a note dated Monday, citing the bank’s forecasts for the greenback to fall further, but only a bit more for the rest of the year.

Watch the currencies

Its strategists have cut their emerging market currency overweight to neutral.

“From current levels, JPM does not have any further upside to EM FX index in 2018, which suggests EM equities might be capped, too,” the note said.

Another factor weighing emerging markets: JPMorgan said that while developed markets will tolerate expected higher bond yields, but it added that emerging markets could “struggle somewhat more” if the Federal Reserve proves more hawkish, or inflation speeds up.

Watch the valuations

JPMorgan added that emerging market valuations were also at broadly fair value compared with historical levels, and without a meaningful discount. It noted that the frequent bullish claim that emerging market earnings have a lot of “catch up” may not be particularly true this time.

“There might not be all that much of an earnings cushion in case of global growth downturn,” it said, noting most emerging market countries already have earnings above previous highs and even many developed markets.

Watch the earnings

“To be clear, we believe that earnings will remain a support for emerging market equities this year,” it said. “But as U.S. and European earnings are also expected to grow double digit, EM is unlikely to benefit disproportionately,” it said.

Additionally, the trade disruption risk for emerging markets shouldn’t be dismissed, JPMorgan said. If there’s an escalation of trade fears, many emerging markets will be hit as they export the most to the U.S., the bank said.

But overall, JPMorgan said it was bullish on equities in general and still expects emerging markets equities will rise this year, along with developed markets.

“But for now, we think that they are unlikely to strongly outperform,” it said, advising staying neutral between the two segments.