(Bloomberg) -- Amid the banking turmoil that’s sent global capital markets into a tailspin and raised the prospect of a full-blown recession in the US economy, true believers in the bull case for emerging markets are digging in. 

For veteran managers from Franklin Templeton to Morgan Stanley Investment Management and State Street Corp., the tumult in major markets has reinforced the case for developing nations. They say the adoption of stronger risk-control measures for corporate and government assets stands to reward bulls with heftier payoffs, while policymakers in the developed world benefit from a head start over peers in the US and Europe in fighting against inflation.

“We are investing more as we speak,” said Franklin Templeton’s Chetan Sehgal. “For us, there is ample opportunity at all points in time within the market. There is enough value.”

The conviction, at least for the emerging-market bulls, is that some of the recent selloff was triggered by shifts in risk sentiment elsewhere. The banking turmoil spurred a repricing of bets on how much further the world’s most-influential policymakers will increase interest rates, with bond traders now eyeing potential Federal Reserve cuts later in the year. 

The case for the Fed to forgo an interest-rate hike strengthened over the weekend after UBS Group AG agreed to buy Credit Suisse Group AG in a government-brokered deal, while the Fed and five other central banks announced action to boost dollar funding.  

While a pronounced slowdown in the US is bound to impact economies globally, less tightening by major central banks and a sluggish dollar may help a bounce in developing assets once the dust settles, said Jack McIntyre, a money manager at Brandywine Global Investment Management.

“This is not stress emanating from EM,” he said. “People are going to sell any risk asset, but if you extend your time horizon a little bit, this could be a net positive because it gets central banks not having to tighten as much.” 

Growth is the key. Developing nations are still expected to expand at a faster pace than their mature peers, improving the outlook for earnings. 

“We still like the emerging markets equity trade that is held at very underweight levels in institutional portfolios,” said Daniel Gerard, senior multi-asset strategist at State Street Corporation, which has $3.5 trillion under management. “They are starting to see a better earnings outlook and get a tailwind from better demand and desire to return to normality in portfolios.”

Chinese equities are “one of the few good stories” across global financial markets this year, he said. 

On Friday, China’s central bank cut the amount of cash banks must keep in reserve in an effort to stimulate the economy. Market watchers were divided on whether the move was a reaction to the stresses seen in the global banking sector last week. The country makes up about a third of the MSCI Emerging Markets Index. The gauge ended the week down 0.4%, but it’s fallen more than 9% since a late-January peak. 

Options traders are also now betting there’ll be less turbulence in developing nations than rich countries. The CBOE Emerging Markets Volatility Index, the equivalent of VIX, has traded below the US fear gauge for the past six sessions.

After a strong start of the year, demand for emerging-markets assets was waning even before the collapse of Silicon Valley Bank. High-profile corporate meltdowns at India’s Adani Group and Brazil’s Americanas SA prompted analysts to flag growing risks of a second-straight year of limited capital markets access.

Omotunde Lawal, head of emerging-market corporate debt at Barings Ltd. in London, said the past week’s banking woes risk a chain reaction that makes it simply too risky to predict what happens next. Treasury yields plunged anew on Friday as financial risk continued to rock global financial markets.

“There’s a lot of things that are piling up on the horizon which give us some pause,” she said. “A lot of companies will struggle to access the capital markets, which can set off a chain reaction of stress.”

At JPMorgan Chase & Co., strategists including Jonny Goulden and Saad Siddiqui declared in a report that a “tactical window” to invest in emerging-market fixed income had closed. They cut a recommendation on local-currency debt to market-weight from overweight and shifted to underweight in their benchmark index for hard-currency sovereign debt.

“Events are supporting the view that we are in a late cycle market environment which EM assets will need to contend with and which calls for reducing risk in EM fixed income,” they wrote.

Better Dynamics

Banking risk in developed markets, however, has yet to affect the case for long-term expansion in emerging markets, where valuations are more attractive than in major developed nations, according to UBS Global Wealth Management.

“If I look at the developments more recently, I don’t think that changes our view at all,” said Themis Themistocleous, head of EMEA investment at the firm, with a multi-asset portfolio. “Growth dynamics are a lot more interesting for emerging markets,” adding that UBS is positive on emerging market equities and dollar debt, while underweight US equities and neutral on global equities.

Jitania Kandhari, deputy chief investment officer and head of macroeconomic research for emerging markets at Morgan Stanley Investment Management, echoes the sentiment. 

“At the moment, excesses in the financial system are in the developed markets,” said Kandhari, who earlier this year predicted a decade of emerging-market outperformance. “They are the ones that had very low rates for years with excessive borrowing. Emerging markets actually have better debt ratios.”

--With assistance from Srinivasan Sivabalan.

(Updates with UBS agreement to buy Credit Suisse.)

©2023 Bloomberg L.P.