After emerging markets' comeback rally this year, it's time to take some profit off the table, JPMorgan Cazenove said in a note Monday.
The MSCI Emerging Markets stock index has climbed around 12 percent so far this year, after a long downtrend ever since mid-2013, when the U.S. Federal Reserve first broached the idea that it would begin tapering its asset purchases, spurring massive outflows from the segment.
But so far this year, the consensus has turned "constructive" on emerging markets, JPMorgan Cazenove noted, adding that it had been overweight emerging markets compared with developed markets since the first quarter.
But now it believed this was a "good opportunity" to take profit, calling the move a "tactical" downgrade to neutral as valuations in its emerging market basket were "swiftly moving towards outright expensive territory."
It cited concerns that the Fed appeared headed for a December interest rate hike.
"Rising foreign-exchange and bond volatility could be a problem again, as expectations of a December Fed hike build," it said. "The dollar is moving back to the top of this year's range, emerging market foreign exchange is trading weaker again, and the Chinese yuan is hitting fresh lows."
The U.S. dollar index, which measures the greenback against a basket of currencies, has climbed recently. It was at 97.703 at 10:28 a.m. HK/SIN time, up from levels under 95 in mid-September.
The yuan has lost ground against the dollar, hitting six-year lows recently. At 10:31 a.m. HK/SIN, the greenback was fetching 6.7392 yuan, compared with levels below 6.12 yuan in August.
A stronger dollar tends to weigh on returns in emerging-market assets as local currencies fall and the cost of servicing dollar-denominated debts becomes more onerous.
JPMorgan Cazenove also noted that emerging market economic activity could "hit an air pocket" in the near term, citing disappointing China trade data and stalled purchasing managers' index data across emerging markets.