Fragile EMs, here’s a reason not to fret

The migration of money from emerging markets to developed economies will continue this year -- but at a slower pace, analysts say, a rare piece of good news as developing countries brace for the first possible rise in U.S. interest rates since 2006.

"My view is that we may be getting to the end of the period of underperformance; not across the board with commodity producing economies in particular still going to be hit," Neil Shearing, chief emerging markets economist at Capital Economics, told CNBC.

"But if you think about all the headwinds emerging markets have had to face – a slowing economy in China, big falls in commodity prices and commodity producing EMs, and the shift of policy accommodation to policy tightening in the U.S., these have probably now largely been priced in," he added.

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Since the 2013 "taper tantrum" when fears about the unwinding of U.S. monetary stimulus hit global markets, emerging markets in particular have witnessed a sharp exit of cash.

According to the Institute of International Finance, total private non-resident capital flows to emerging markets subsided to just under $1.1 trillion in 2014 from an all-time high of $1.35 trillion in 2013.

It forecasts that capital inflows will dip a further $25 billion in 2015 to $1.06 trillion, before staging a moderate recovery in 2016.

Indeed, the rotation into developed markets from emerging ones comes against a backdrop of optimism about the outlook for the U.S. economy and brighter prospects for Europe amid aggressive monetary stimulus from the European Central Bank.

The MSCI Emerging Market Index is up about 2.7 percent so far this year. That lags a gain of about 17 percent in the pan-European Euro Stoxx 600 index, and a 13 percent rally in Japan's Nikkei index but just ahead of the S&P 500 which is up about 2.2 percent.

"The view we had coming into this year was that a) we wanted to be overweight equities relative to other asset classes, b) we wanted to be overweight developed markets [DM] over emerging markets and thirdly within DM we wanted to be overweight non-U.S. markets with a preference for Japan and Europe," Goldman Sachs Chief Global Equity Strategist Peter Oppenheimer told CNBC Monday.

Be selective

Analysts add that while developed markets have the edge over their emerging peers for now, reforms in some big emerging markets have helped individual countries stand out against their peers.

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For example, India's stock market has soared almost 30 percent over the past year and is up just over 2.5 percent this year, boosted by the economic reform efforts of a new government under Prime Minister Narendra Modi who was elected last May.

"A lot of the rotation from emerging to developed economies is associated with the stronger dollar. A lot of it, associated with the fact that a lot of larger EM countries are a shambles – that would be Russia, Brazil, South Africa," said Marc Ostwald, a strategist at ADM Investor Services International in London. "India is the exception and since the election there has been a huge rotation into Indian stocks."

Shearing at Capital Economics added: "I'm not saying EMs are going on a tear from here and our forecast is for modest gains of 5-6 percent over the next year or so, but in relationship to developed markets, the big period of underperformance may well now have happened."

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