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BlackRock upgrades emerging market stocks

An employee counts Thai one-thousand baht banknotes, left, at a Super Rich 1965 Co. currency exchange store in Bangkok, Thailand.
Dario Pignatelli | Bloomberg | Getty Images
An employee counts Thai one-thousand baht banknotes, left, at a Super Rich 1965 Co. currency exchange store in Bangkok, Thailand.

Marking Wall Street's latest turn in favor of emerging markets, BlackRock said Monday it upgraded EM equities to overweight as the firm expects a stable U.S. dollar, low rates and a better outlook for growth.

"The most important part and what drives our [view on] the EM performance over the long term is the fundamentals, but you need to be aware of the sentiment around EM. Now both of them have aligned," said Gerardo Rodriguez, portfolio manager of the BlackRock Total Emerging Markets Fund.

He said BlackRock was encouraged in three areas where there had been concerns. For one, there are signs of stability after a sharp slowdown in China's economy. Commodities prices are no longer falling, and the U.S. has not edged closer to recession. Improving current account balances, appreciating currencies and attractive valuations provide fundamental support for investing in EM, Rodriguez said.

U.S. dollar stability is a key factor in that outlook. Strength in the greenback puts pressure on emerging market nations, which may be forced into a competitive devaluation of their currencies to remain competitive, while finding it harder to pay down dollar-denominated debt.

Now, "the 'lower-for-longer' rate outlook reduces the risk of a sharply rising U.S. dollar, expands the scope for EM rate cuts (25 so far this year), and makes high-yielding EM assets relatively attractive," BlackRock analysts said in a note Monday.

Meanwhile, investors searching for returns in a low-growth world increasingly favor emerging markets. The iShares MSCI Emerging Markets ETF (EEM) is up more than 15 percent year to date, versus about 6.8 percent gains in the S&P 500.

In April, Bank of America Merrill Lynch reversed its five-year negative view on emerging markets to become "structurally bullish" on the asset class.

BlackRock was neutral on EM equities back then.

Since the 2013 taper tantrum, about $150 billion has flowed out of EM equity exchange-traded and mutual funds, according to EPFR Global data cited by BlackRock. Investors are now dipping back in — slowly — with $26 billion in inflows since February, the data showed.

"There is a lot of space for inflows to move to EM," Rodriguez said.