Key Points

  • Stocks have faltered since mid-February as the bond sell-off accelerated and the U.S. 10-year yield surged above 1.3%.

  • EM stocks have taken the rise in yields the worst among major equity asset classes.

  • We provide five reasons why EM stocks can likely still perform well as rates climb this year.

Accelerating growth is generally a good thing for stocks, evidenced by bond yields and stock prices typically rising and falling together. Yet, emerging market (EM) stocks have faltered since mid-February as the bond sell-off accelerated and the U.S. 10-year yield surged above 1.3%. Since this year’s peak on February 17, the MSCI Emerging Market Index has fallen -7.3%, more than twice the decline in developed market stocks of -3.1%, as measured by the MSCI World Index. This begs the question: have EM stocks lost their immunity to rising rates? We provide five reasons why EM stocks can likely still perform well as rates climb this year.

EM stocks part ways with interest rates since mid-February

Source: Charles Schwab, Bloomberg data as of 2/26/2021. Past performance is no guarantee of future results.

Yields may not stop here

Bond yields may continue to climb, making this an important issue for EM stock investors to watch. Last week’s U.S. durable goods and Eurozone economic confidence reports were just a couple more examples that highlight the trend of better than expected economic data coming from around the world. Economists and bond markets appear to have underestimated the recovery.

Economic surprises continue to be on the upside

Source: Charles Schwab, Bloomberg data as of 2/25/2021.

Thus far, the surge in the U.S. 10-year Treasury yield is not that unusual. If we look back at the past 10 years, we can see many other periods where yields surged by an average of 100 basis points over a period of about 200 days, similar to the recent episode that began on August 4, 2020. On average, EM stocks have tended to post gains, during these rapid surges in yield, as you can see in the table below.