Increasing comfort with the outlook for China's economy will make emerging market equities the best performing asset class in the second half of 2014, according to financial services firm ING.
Recent Chinese economic data point to stabilization in the world's second-largest economy, helped by Beijing's targeted stimulus measures. This is positive for emerging markets, many of which are dependent on exports to the mainland.
May retail sales, for example, rose 12.5 percent on year, above analyst expectations for a 12.1 percent increase. While fixed asset investment rose 17.2 percent on year for the January-to-May period, just above expectations for a 17.1 percent rise.
"We expect reduced China growth anxiety will make emerging market equities the top-performing asset class in the second half of the year or until markets start re-pricing for the Fed's lift-off from the zero lower bound, which we think will trigger a volatility spike and increased investor risk aversion," Tim Condon, Head of Research and Chief Economist, Asia at ING wrote in a note.
The return of capital to emerging markets also reflects recent signs of stabilization in Ukraine and attractive yields and valuations. In May, emerging markets attracted $45 billion from global stock and bond investors, the highest level of portfolio inflows since September 2012, according to global financial industry group Institute for International Finance (IIF).
Emerging markets equities are up 3.9 percent year to date, slightly underperforming global stockswhich have risen 4.1 percent, according to the MSCI Emerging Markets and MSCI World indices.
India and Southeast Asian markets have been the biggest beneficiaries, said Tai Hui, chief market strategist, Asia at J.P. Morgan Funds.
"Markets that were battered into 2013 are seeing a revival because of good policy from the central banks, as well as economic momentum is not as poor as people initially thought. So I think a lot of the oversold positions are now being bought back," he said.
Strategists at Coutts Investment Office, a division of private bank Coutts & Co., agree emerging markets are the place to be.
"Currency issues facing the 'fragile five' emerging markets (Brazil, India, Indonesia, South Africa and Turkey) have dissipated, reflecting improved fundamentals in India and Indonesia, and better value following the currency sell-offs," they said.
"We believe some of the additional liquidity that will be provided by the European Central Bank's (ECB) recent monetary easing will find its way into emerging markets. While the interest-rate cuts and refinancing operations introduced by the ECB earlier this month will add only a modest amount of liquidity, this will help offset the trimming of bond purchases (quantitative easing) by the U.S. Federal Reserve in terms of the overall impact on funds flowing into emerging-market assets," they added.
In addition, Coutts strategists note that earnings momentum in emerging markets is rising for the first time since early 2012, and appears to be outstripping momentum in developed markets. "We see this also feeding into outperformance of emerging over developed equities," they said.