The outlook for emerging markets (EM) looks positive as the US Federal Reserve signals a shift to a more accommodative monetary policy amid other headwinds.

In particular, economic fundamentals are much better than previous years, according to investment executives, and developing countries are showing resilience and growth potential despite central bank hawkish indications.

Earlier this month, Oxford Economics’ latest hawkish index for July, measuring the relative aggressiveness of central banks, found that EM hawks remained bullish, suggesting that many economies are likely to overshoot their inflation targets.

"The continued aggressiveness of monetary policy poses a significant risk to EM demand growth," it said.

"In the short term, central banks may justify tightening policies as progress in reducing inflation has slowed and due to increased volatility in financial markets. But our real-world activity tracker reveals that activity has lost momentum in EM with the highest hawkish index.”

It maintains its overall GDP growth forecast for 2024. of EM of 4 percent, but lowered its forecast for 2025. to 3.9 percent. It has also raised its interest rate forecasts for most developing countries in 2024. and 2025

Offering country-specific information, he noted that central banks in Mexico and the Philippines, among others, had cut rates amid signs of slowing growth. Meanwhile, Brazil and Malaysia are expected to keep rates on hold, marking the risk of cuts if inflation expectations do not fall.

Despite these mixed results, emerging market investors remain optimistic about the trajectory of these markets in the coming months.

According to Joseph Lai, chief investment officer at Ox Capital, EM central banks' monetary policy has been "sensible" in balancing inflation with economic growth.

“Central banks in Asia and emerging markets are keeping interest rates high to match relatively high interest rates in the US. Despite the higher rates, most of these economies do not have significant inflationary pressures and are growing steadily,” he told InvestorDaily.

With US Federal Reserve President Jerome Powell indicating last week that "the time has come" to ease monetary policy and near-confirmation of a rate cut in September on the horizon, the outlook is good for emerging market stocks, he said Lai.

"The impending US rate cuts and a weaker US dollar are strongly positive for emerging markets and EM stocks have historically performed well during US rate cut cycles," he said.

Economies such as India, Indonesia and Vietnam are thriving despite a slowdown in other markets such as China and the U.S., Lai noted, and valuations in developing countries are generally attractive, trading at multi-decade lows on price-to-earnings and price/ accounting estimates.

This, he continued, is an important fact given that emerging market stocks have historically outperformed developed markets over the long term.

"The general lack of interest has resulted in extremely attractive valuations," he said.

"We are looking at an attractive entry point at a forward price to earnings low for quality companies with sustainable long-term growth and a backdrop that supports excellence."

Moreover, this trend will only benefit from the high interest rates that are rapidly falling in these economies.

"For example, Indonesian banks are experiencing strong growth, minimal credit issuance, generating high returns on equity, trading at attractive price-to-book ratios and offering dividend yields as high as 6-7 percent," Lai said.

Samuel Bentley, client portfolio manager at Eastspring Investments, also suggested that select EM central banks are likely to cut interest rates alongside the Fed tapering, especially amid stabilizing domestic inflation and a slowing economy.

"This could provide a favorable environment for local equity and local currency bond markets," he told InvestorDaily.

Over the next 12 months, as the easing cycle overlaps with the US election cycle, he sees lower uncertainty, lower interest rates and a weaker US dollar as structural support for emerging market equities.

Emerging market stocks could even perform in line with U.S. stocks, albeit with increased volatility, in the second half of 2024, Bentley noted.

"We have seen a widening of aggregate GDP growth expectations for emerging markets relative to developed markets over the next few years, which typically correlates with equity market outperformance for emerging market stocks," he said.

Like Lai, he also highlighted relatively cheap valuations in EMs, which could prove profitable. In particular, he pointed to Latin America, where the firm sees many valuation opportunities, particularly Brazil and Mexico, as well as South Korea and China, where market pessimism continues to put a price on extreme results.

"The historically low positioning of EM investors plus very supportive relative valuations means that if there are no obvious headwinds, the cheap valuation alone could lead to a much stronger performance in EM," Bentley said.

"EM stocks are trading at least one standard deviation cheap relative to historical averages, while the US is more than one standard deviation expensive."