UBS: Emerging markets present an opportunity for "increased holdings", with the Chinese stock market expected to lead the way.

UBS's latest report points out that against the backdrop of a global economic slowdown, a shift in Federal Reserve policy, and a weakening US dollar, emerging markets are entering a tactical allocation window, particularly the Chinese stock market, which is expected to lead this round of rebound. Dollar depreciation and expectations of Fed easing dominate the market UBS predicts that the Federal Reserve will cut interest rates by 100 basis points before the end of 2024, far exceeding the current market price of 68 basis points. This easing expectation will drive the US dollar lower, providing support for emerging market assets. Historical data shows that for every 1% depreciation of the dollar, emerging market equities on average rise by 3%. In addition, the decline in US real yields, loose monetary policies in emerging markets, and valuation discounts relative to US stocks all provide tactical opportunities for emerging market assets. However, UBS also warns that further depreciation of the US dollar may come at the cost of an increased expectation of US economic recession, which could pose a challenge to popular emerging market arbitrage trades. Especially, Chinese credit growth, export performance in emerging markets, and overall risk appetite have already been priced in, limiting the upside potential in the markets. Bullish on emerging markets, China is expected to lead the rally UBS's global equity strategy team has upgraded its rating on emerging markets to "overweight," believing that the conditions for outperforming US stocks tactically have matured. The four main factors supporting this assessment are: dollar depreciation, declining US real yields, loose monetary policies in emerging markets, and valuation discounts of emerging markets relative to US stocks still being higher than the long-term average. In terms of specific markets, UBS is particularly bullish on China. Despite external pressures and internal structural adjustments, the Chinese stock market still shows resilience in earnings, reasonable valuation (with a 20% price-to-book ratio discount relative to other emerging markets), and sufficient room for domestic fund rotation. Additionally, Brazil is also considered an attractive target for allocation among large markets. Differentiation between China and other markets intensifies, local debt becomes more attractive In terms of fixed income strategy, UBS emphasizes that the growth and inflation cycles in China are decoupling from other emerging markets. China's strong exports and fiscal consolidation efforts make it relatively independent in a global interest rate decline cycle. This explains why the 30-year government bond yields in developed markets such as Europe and Japan have plummeted, with limited impact on emerging markets, while Mexico and Thailand's 30-year government bond yields have dropped by over 125 basis points year-to-date. UBS expects overall inflation in emerging markets to continue falling, supporting further interest rate cuts by central banks. In this context, local debt (especially after FX hedging) is expected to outperform credit debt. UBS predicts that the EMBI Global Diversified Index (EMBI GD) spread will expand to 360 basis points by the end of the year (currently at 300 basis points). In conclusion, UBS believes that emerging markets are currently in a tactical allocation window. Dollar depreciation, expectations of Federal Reserve interest rate cuts, loose policies in emerging markets, and valuation advantages provide temporary support for assets in this region. In terms of foreign exchange, low volatility, high yield currencies are recommended; in stocks, China is expected to lead the way, with Brazil also being attractive; in fixed income, local debt is preferred over credit debt, but some high valuation CDS should be avoided.