Emerging markets have begun a process of healing in recent months, kick-started by aggressive healthcare and economic policy actions globally. We expect a bumpy recovery, with shocks from the coronavirus pandemic likely to have long-lasting, albeit varied, effects on the outlook for markets and economies.

Yet we remain confident that massive monetary and fiscal stimulus will continue to limit market volatility, which is near 20-year lows, and support emerging markets (EM) investments.

Turn in the cycle

At PIMCO, we use a top-down framework to assess how global conditions will impact EM investments, focusing on changes in three primary drivers – the business, liquidity and political cycles.

With policymakers firmly erring on the side of doing more, we think major central banks will continue to support the liquidity and business cycles for a long time.

In our view, however, the effect of this policy support in some countries will likely be tempered by accelerating populist policy trends, making country-specific risks more important. The upcoming U.S. election and its potential impact on relations with China and other countries will take center stage.

The improving business cycle is positive for emerging markets.

EM returns typically are strongest when the global manufacturing PMI — a good proxy for economic activity — is below its long-term average of 51.4 and rising, as it is now (see Figure 2).

A steady grind higher and a broadening rebound are more relevant than the exact shape the recovery will take, given the strong liquidity support. Near-term drags associated with the pandemic are to be expected, but we believe these will be more localized going forward.

With global monetary and fiscal policy likely to remain supportive for a long time, we believe the manufacturing index can return to its mean, lifting EM returns in coming quarters.