Emerging markets were facing headwinds going into 2014, but January's rout surprised even the gloomiest of investors, with big declines in stocks, bonds, and currencies.
Political turmoil and terrorism threats across market capitals from Ankara to Kiev, along with growing concern about bad debt in China's shadow banking system, caused a full-scale pullback across all risk assets.
As a result, some investors are starting to see attractive values in these markets. Sentiment remains weak, however, so the actions of emerging market policymakers will determine whether investors take advantage of low valuations or opt to preserve capital, strategists say.
"From our view, the valuations in this sector, be it hard currency (debt), local currency (debt), EM FX, corporates, are becoming compelling. Look, that is the first time I have been even close to bullish on emerging markets for a while. But it is on a relative risk/return basis," said Paul DeNoon, senior debt portfolio manager at AllianceBernstein in New York.
"The market has discounted a lot of bad news. I think with a lot of policy responses in the better countries, some opportunities have developed," he said, pointing to relative value in Indonesian, Brazilian and Turkish credits which have fallen far and fast.
In just a month, the broad MSCI Emerging Markets stock index is down 7.5 percent versus a decline of 5 percent for all of 2013, a year when developed markets surged by 30 percent. The benchmark U.S. S&P 500 stock index is down 3.6 percent year-to-date.
Yield spreads between emerging market sovereign debt and comparable U.S. Treasuries widened by nearly 50 basis points, according to JPMorgan's benchmark indices, the largest one month increase since June of last year when the Fed's first hint at reducing its monetary stimulus rattled global markets.
Turkey, India and South Africa have recently surprised markets with aggressive defenses of their currencies. Their actions come as the Fed moves toward more normal monetary policy that will cause less money to move abroad in search of higher returns.
Emerging market currencies have lost ground against the U.S. dollar and the euro. Bank of America Merrill Lynch (BAML) research said that in aggregate, emerging market currencies are now undervalued by about 2 percent, a sharp swing from 2010-2013 period when they were considered overvalued.
The bank sees cheap medium-term bonds in South Africa and Brazil. Mexico, Poland, Hungary and Malaysia look to be fairly priced, they said.
The aggressive rate hikes from central banks in