Former emerging market pariahs have been among the world's best-performing stock markets this year as investors bet that reforms in struggling economies like Argentina and Pakistan will help them leave the worst of their currency problems behind.
Argentina's Merval index led Latin American bourses, rising 53% in US dollar terms, while Pakistan's stock index was one of the best performers in Asia as markets that until recently were considered deeply distressed outperformed their larger, more expensive peers.
So-called frontier markets are attractive because of their cheap valuations, investors say. In contrast, indices in more established markets such as Mexico and Brazil have fallen in dollar terms as capital has been drawn to booming U.S. stocks in the artificial intelligence sector.
You have a loud sucking noise coming from the United States, called [chipmaker] Nvidia, which has been pulling its money out of big emerging markets, said James Johnstone, co-head of the emerging and frontier markets team at Redwheel, an investment manager.
But what works well are markets that have gone through near-existential crises and carried out the necessary reforms, he added.
A group of developing economies, including Sri Lanka and Turkey, have been through very difficult times but are now poised to recover as costly foreign currency debts and double-digit inflation rates are under control, Johnstone said.
In Pakistan, the Karachi stock market has gained 30% since the start of 2024, more than benchmark stock indices in Taiwan and India. Its value in dollar terms has nearly doubled since June last year, when the country avoided default by securing a $3 billion loan from the IMF.
The recent surge is due to investors' confidence that Pakistan will get a long-term arrangement with the IMF after the successful conclusion of the Stand-By Arrangement last year, said Mohammed Sohail, managing director of Pakistani brokerage firm Topline Securities.
Even after the recent rally, Pakistani stocks are still trading at around 3.7 times earnings, about half the historical average of seven, Sohail added.
The biggest contribution to the upside came from the banking sector, which benefited from bumper profits as the central bank raised its policy rate to more than 20% to curb runaway inflation, according to a research note from Arif Habib Limited, a Pakistani brokerage firm.
Still, foreign flows into Pakistani stocks remain minimal and the turnaround is more a reaction to lower food and fuel inflation, which spiked after Russia invaded Ukraine, said Dominic Bokor-Ingram, senior portfolio manager in emerging and frontier markets at Fiera Capital. “We don’t see this as a reform story, but a rebound from very low levels,” he said.
Some border stock markets have lagged in the first half of the year in dollar terms due to recent currency devaluations. The Egyptian stock market, for example, has fallen 27% this year, hit by the devaluation of the Egyptian pound in March.
Even among the group of countries that have seen stock market gains, economic conditions remain generally difficult for ordinary citizens. Inflation often remains high relative to other emerging markets, despite a sharp rise in interest rates in Turkey. Inflation slowed for the first time in eight months in June, but it remains at 71.6%. A number of governments are facing resistance to their plans to raise taxes to repay debt.
The Nairobi stock index has jumped 44 percent in dollar terms this year as Kenya avoided a looming bond default and the shilling gained more than a fifth against the dollar.
But last month, President William Ruto withdrew a finance bill, part of a plan to comply with the IMF bailout, after a deadly crackdown on protests against what were seen as onerous tax measures backfired.
Pakistan's finance ministry unveiled a fiscally-heavy budget last month aimed at boosting revenue and allaying IMF concerns as the country's shaky governing coalition seeks a path out of sluggish growth, double-digit inflation and soaring public debt.
Argentine President Javier Milei has passed the economic measures into law more quickly than previous attempts at reform that have been mired in political opposition, Bokor-Ingram said. The difference between this time and all the previous ones is the speed with which Milei has proceeded.
Frontier markets and larger, more idiosyncratic markets such as Argentina have also appeared on the radar of investors trying to control their exposure to large emerging markets such as China.
But despite promises of reform in some countries, many investors are aware that emerging market equity returns have been generally weak over the past decade relative to U.S. markets, one emerging markets equity manager said. Ultimately, he added, you’re just in a highly cyclical asset class.
