Market Insider

Bear market in emerging debt is over: BlackRock

Emerging markets should continue to outperform this year, even with the lingering problems of slow growth, rising inflation and too much debt, according to BlackRock's emerging markets team.

Despite the gains, BlackRock says the bear market in emerging market debt is over. BlackRock's EM team, which manages $12.3 billion, says the headwinds from earlier in the year are be coming tailwinds.

They pointed to recovering oil prices, less volatility around China's currency, and most importantly—the weaker dollar.

A worker polishes steel coils at a factory of Dongbei Special Steel Group in Dalian, China.
China Daily | Reuters

"The dollar is super important to our call on emerging markets," said Pablo Goldberg, Portfolio Manager for BlackRock's Emerging Market Debt Team. The dollar has had an outsized impact on emerging markets since the dollar denominated debt most of these countries easier to pay off.

These markets still risk a disruption from Federal Reserve interest rate hikes, which could send the dollar higher.

However Goldberg told CNBC if the Fed assumes a slow and gradual pace to tighten ingrates, emerging markets will not endure the same level of pressure experienced in the past.

"If the China story can stay relatively stable while the Fed tightens then there is less of a reason for emerging markets to sell-off," he said.

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The big question for markets is whether China really is in an economic turnaround.While investors have been impressed with the recent upside surprises in Chinese economic data, skeptics say this is simply the result of debt and loan issuances. Market watchers are also hesitant about the accuracy of Chinese economic data.

"The opacity around China's data does complicate our analysis," said Goldberg.

This point was seconded by Peter Boockvar of the Lindsey Group who highlighted Tuesday the extreme weakness in Hong Kong's trade data. "The monthly joke now is how the Hong Kong trade data exposes the nonsense that is the Chinese trade data," wrote Boockvar.

Hedge funds seem to be less interested as well. According to the latest report from financial data firm eVestment, hedge fund investors withdrew money from China-focused funds in the month of March. Outflows estimated at $373 million representing the largest wave of redemption pressure for these products since losses emerged in second half of 2015, wrote analysts at eVestment.

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Yet,capital outflow numbers are stabilizing—a sign that Chinese investors aren't running for the door.

The International Institute of Finance is estimating net capital outflows to slow to $538 billion in 2016—which is lower than the $674 billion taken out last year. However Emre Tiftik, Deputy Director at the IIF, writes that "there [still] remain risks that outflows could accelerate again if concerns about RMB depreciation intensify."

Yet, some Beijing watchers say capital outflows are the least of China's troubles.The main challenge is centered upon China's steel sector, according to Teneo Intelligence.

"Reforming China's state-owned industrial sector remains one of Beijing's biggest challenges in its effort to overhaul the country's economic model. Nowhere is the combination of external pressures and domestic dilemmas facing Chinese policy-makers more prominent that in the ongoing restructuring of the steel sector," wrote Andy Liu, Senior Vice President at Teneo Intelligence.

—By CNBC's Seema Mody. Follow her on Twitter: @SeemaCnbc