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Why the emerging market dream story may be over

2016 was billed as the year emerging markets (EM) would make a comeback, but some analysts say the years of stunning growth in developing economies are over.

EMs have faced a tough ride since late 2013 after the U.S. Federal Reserve decided to start rolling back its massive bond-buying program. A few economies have also struggled with weak currencies and high current account deficits and came to be known as the "Fragile Five." These countries included India, Indonesia, Brazil, Russia and Turkey.

Following this, the slump in commodity prices and fears of a Chinese slowdown kept the pressure on these economies. Things have however started to improve for a few countries, like India and Indonesia, who worked to introduce political and economic reforms.

"The emerging markets growth story was a phase, but nevertheless investors who have a strong presence in emerging markets will continue to facilitate a process of expansion that will result in strong returns," Levy Raiz a Partner at venture capital fund Flint Capital told CNBC via email.

The MSCI emerging markets index has risen 1.1 percent this year after a fairly rough start to 2016. Chinese stocks tumbled early in the year due to weaker-than-expected manufacturing data, depreciation in the yuan and the introduction of circuit breakers in the stock market.

"Emerging market equities have been in a downtrend since 2011, characterized by bear market rallies, which have been sparked by valuations and sentiment hitting extreme levels and economic data bottoming," Patrick Cadell, manager of the Liontrust Global Fund, told CNBC via email.

"While we believe a return to earnings growth is possible in some markets, conditions in others are not conducive to an improvement in earnings," he said.


Raiz added that countries including Thailand, Malaysia, Turkey and Brazil were likely to come under renewed pressure in terms of economic growth, as investors digested the most recent price action and focused again on fundamentals.

For EM equities to outperform, economic growth expectations in emerging markets need to improve, Emily Whiting, a client portfolio manager at JPMorgan Asset Management, said.

"(Developed Market) economies are likely to grow at their current pace for the next year or so – it is therefore emerging market expectations that need to gain momentum," she said in a research note.


Watch Fed and oil

Speculation continues as to whether the U.S. Federal Reserve may hike interest rates again in June. This would likely impact the U.S. dollar – and assets around the world, including in EM.

In addition, rising interest rates in the U.S. and other major economies might see yield-hungry investors make their way back into developed markets.

"In the near-term, much depends on the path of the U.S. dollar, which tends to heavily influence emerging market flows and valuations," Whiting, who specialises in EM and Asia-Pacific, said.

Already, African currencies have declined on average year-to-date, according to a report earlier in May from pan-African Ecobank. It attributed this in part to the strength in the U.S. dollar.

Meanwhile, oil prices have rebounded somewhat, with WTI and Brent crude flirting with $50 per barrel. Rising oil prices may be a downside risk for countries that are commodity importers like India, currently one of the fastest-growing major emerging economies. Another concern for India is that Raghuram Rajan, the feted governor of India's central bank, ends his term in September. Some analysts have attributed the respite in the country's falling currency and high current account deficit to Rajan's policies.


However, EMs represent about 70 percent of the world's population and their populations are rising – so gross domestic product (GDP) growth is inevitable, even after the recent slowdown in some regions, said Flint Capital's Raiz.

He added that the hype surrounding EMs caused a lot of investors to jump in without enough research or strategy – and then they lost money.

"But investors who succeeded (in) understanding local culture and establishing themselves will harvest serious returns in the next 10-15 years," Raiz concluded.

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