Fastest Rally in History Takes Emerging-Market Stocks to Record

(Bloomberg) -- The emerging-market equity benchmark rose to a record, topping its previous high reached before the 2008 financial crisis, as a flood of liquidity and optimism over a global economic rebound fuel risk appetite.

The MSCI Emerging Markets Index rose 2.4% to 1,353.53 points as of the Friday close, extending its recovery from the March rout to 80%. The milestone comes after stock valuations and market capitalization both reached record highs in a rally that's added $10.8 trillion in a little over nine months, the fastest bout of wealth creation in the history of emerging markets.

While the flurry of records underscores the strength of the risk-on shift in global markets since Joe Biden's victory in U.S. elections, it is already sparking nervousness among some investors that emerging equities are overheating. Even though earnings estimates continue to rise, the index has surged so fast that technical indicators are flashing red. Short traders have bet record amounts the gains are unsustainable. And a rise in volumes signals a sense of urgency among traders.

Biggest Gains in Emerging Markets

Yet, for the moment, investors may be forgiven for savoring the record, which has come after a wait of 13 years. Emerging-market stocks have underperformed U.S. peers over the past decade and often bore the brunt of risk-off shifts ranging from the taper tantrum to slowing growth in China and Donald Trump's trade war.

But developing nations have also been a picture of resilience. Equity values, driven by the addition of countries such as Saudi Arabia and Pakistan to the asset class, have almost doubled since the previous record high to $26.2 trillion. The MSCI gauge now trades at 15.8 times the projected earnings of its members, compared with its 15-year average of 11.2. Analysts have raised profit forecasts for the index by 24% in the past nine months.

Still, with annualized volatility of about 25%, emerging-market stocks remain vulnerable to sudden changes in direction. While the risks surrounding the pandemic and U.S. presidential transition may have waned, there are many threats that could yet arrest the rally.

U.S. Treasury yields are rising, which may force traders to demand a higher earnings yield from developing-nation equities, leading to a drop in stock prices. Any surprise in Biden's foreign and trade policies may have to be factored in. Growth recovery across emerging economies remains uneven and struggles with mass vaccination could spell trouble.

Any celebration over the MSCI Index reaching a record would have to be short, and tempered by measures to protect against potential losses. The relative strength index on the gauge's monthly chart has reached the so-called “overbought” level of 70, which has heralded bear markets in the past.

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