LIVE MARKETS-Ashmore expects long-term bonanza for EMs as dollar's smile loses shine

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ASHMORE EXPECTS LONG-TERM BONANZA FOR EMS AS DOLLAR'S SMILE LOSES SHINE

The "dollar smile" is looking more like a grimace.

Asset manager Ashmore says the recent simultaneous sell-off in U.S. stocks and the dollar confirms its theory of a breakdown of the 'Dollar Smile' theory - and that could trigger major asset allocations away from the U.S. into the rest of the world.

The 'Dollar Smile' is the idea that the dollar will outperform peers in contrasting economic conditions - during both an exceptionally performing U.S. economy, and under weak global economic conditions in a 'risk-off' environment.

However, for every percent U.S. assets shed, assets in emerging markets see the potential for larger gains. Ashmore analysts say that this 'tsunami' of an allocation shift is likely to be a decade-long trend, taking into account the 'overexposure' investors have to the star performer, U.S. stocks.

The benchmark S&P 500 .SPX confirmed a correction last week, while the dollar index =USD is set for its worst month in over two years.

"When the Dollar weakens, investors diversify to the rest of the world, driving portfolio and foreign direct investment into EM countries, which supports higher GDP growth and stronger EM currencies," said Ashmore analysts, pointing that it forms a 'virtuous cycle'.

MSCI's index tracking global EM equities .MSCIEF has gained 5.1% this year, while the currencies index .MIEM00000CUS has advanced 1.8%, both easily outrunning the S&P 500 and the dollar.

Ashmore expects local currency bonds in EM to benefit the most, with a tendency of higher returns and lower volatility when the dollar is weakening.

Moreover, optimism around Germany's historic fiscal stimulus package and a potential conclusion to the Russia-Ukraine conflict has been a boon to the euro and kept the dollar under pressure.

Germany's expanded spending is a positive for European EMs such as the Czech Republic, Hungary and Poland where exports to the EU count for over 30% of their gross domestic product, as per Ashmore.

(Purvi Agarwal and Lisa Mattackal)

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