By Karin Strohecker
LONDON (Reuters) - Morgan Stanley (NYSE:MS) said on Monday it had changed its stance on emerging-market bonds and currencies to neutral from negative following the recent selloff, although it warned the backdrop for developing markets remained difficult.
"After a significant sell-off, we close our bearish view on EM and shift into neutral gear," strategist Jaes Lord said in a note to clients. "We can see the case for some temporary stability after a six-month bear market."
Emerging markets had a rough time over the summer after crises in Turkey and Argentina sparked a wider selloff in assets of developing economies.
Following a six-month bear market, Morgan Stanley predicted some temporary stability might occur, thanks to depressed valuations, investors adjusting their positioning and a weaker U.S. dollar.
Some idiosyncratic issues had become less concerning, while policy response to shore up investor confidence had picked up and a further escalation of trade looked built in, Morgan Stanley added.
"However, more material escalatory risks over the medium term mean that this issue should re-emerge as a strong headwind in time and so we do not see the case to move bullish."
Across high-yielding currencies, Morgan Stanley said it "liked" Argentina, Indonesia and Russia and moved to a neutral stance on Brazil. Across local debt, its analysts took a positive view on Mexico and a neutral stance on Argentina, Brazil and Russia.
"Overall, we see the case for local markets as stronger than credit, considering better positioning, valuations that are more consistently cheap across countries and expected dollar weakness," the bank added.
Across emerging-market hard currency debt, Morgan Stanley expected spreads to tighten with more debt issue supply possibly coming to market after a rocky summer, which would keep a lid on a potential rally.
Bond sales usually rebound in September after a quiet August, but this year's currency crises in Turkey and Argentina and worries about rising U.S. sanctions risk for Russia have kept volumes dramatically lower so far.
Morgan Stanley is not the only major bank to take a more positive view on emerging markets. Goldman Sachs (NYSE:GS) said investor sentiment for emerging market assets had been firming.
"Recent price action has likely helped buoy sentiment
for EM assets, but we have noticed a marked change over the past two weeks in investors’ focus on EM - from downside risks to valuation and ‘opportunities’," Goldman analysts Caesar Maasry wrote in a note to clients.
Turkey's interest rate increase in September, softer inflation data from the U.S. and valuations have rekindled "tepid optimism", he said.
"We still prefer equity as the best-positioned asset class for a ‘bounce-back’ and find Brazil, Chile, Peru, Korea, and China offer a good combination of dislocation and supportive
macro growth dynamics," Maasry added.
MSCI's emerging market equity benchmark (MSCIEF) has fallen nearly 10 percent since the start of the year.