(Bloomberg) -- Cracks are appearing in Wall Street’s bullish case for emerging markets as hurdles — from Adani Group’s $108 billion rout to the Federal Reserve’s rate-hiking plans — prompt a more selective approach to investment.

An early 2023 rally in developing-economy assets, fueled by China’s reopening and hopes for looser global financing conditions, is already starting to lose some momentum. As new risks arise, that has Goldman Sachs Asset Management and JPMorgan Chase & Co. among those touting more selective strategies.

“We aren’t in the environment just yet where can indiscriminately buy,” said Angus Bell, a managing director at Goldman Sachs Asset Management in London. “For countries that faced acute stress last year, it’s not really as though the macro environment has shifted so dramatically that all of the problems that they were facing have now totally evaporated.”

For investors, recent events are a reminder of how quickly the mood can shift in emerging markets. 

MSCI Inc.’s index for developing currencies on Monday headed for its biggest two-day decline since March 2020. The gauge had fallen on Friday after data showing a hot US labor market that bolstered the Fed’s case to keep raising rates. That prompted TD Securities to close out of its bullish bet on Brazil’s real as the currency slumped.

The South Korean won and the Thai baht were among emerging currencies on the back foot on Monday as they reacted to the dollar’s gains.

A similar developing equity gauge, tumbled the most since October amid a continuing selloff in Gautam Adani’s sprawling Indian conglomerate and an uptick in US-China tension.

This all comes in sharp contrast with a stellar start to 2023 for the asset class, with Morgan Stanley Investment Management saying the decade of emerging markets had begun. Caesar Maasry, head of emerging cross-asset strategy research and managing director at Goldman Sachs, still expects nearly another 10% of gains in developing stocks.

“I don’t think there’s froth,” Maasry said in a phone interview. “There’s more upside in the EM rally.”

Global Chartbook: Fissures Appear in the Emerging-Markets Story

Still, some assets are starting to look more expensive.

“The main short-term reasons arguing against chasing the rally right now are its speed and magnitude,” JPMorgan analysts including Jonny Goulden said in a Jan. 26 note. Based on the firm’s analysis of risk appetite for emerging currencies, “some near-term caution is warranted.”

Guido Chamorro, co-head of emerging market hard currency debt at Pictet Asset Management in London, also touted the danger of market technicals for global bonds. Compared with last year, investors have eagerly snapped up new debt to build heavier overweight positions, he said. 

“If there are no bumps in the road ahead, this is not a problem,” he said. “However, if we do see bumps in the road ahead, then we could see a bit of a shakeout.”

Investment flows into hard-currency bond funds are already easing somewhat, while local-currency bond funds suffered a recent outflow, according to JPMorgan data.

Debt from Angola and South Africa has become relatively expensive, said Carlos de Sousa, an investor at Vontobel Asset Management in Zurich. While he sees more broad bond gains ahead, there’s risk inherent in Bolivia’s gloomy political and economic outlook if the global tides turn, he said.

Polina Kurdyavko, head of emerging markets at Bluebay Asset Management, said she prefers debt from companies with stable profit margins and consistent cash flows — such as hydro utilities in Latin America and certain quasi-sovereign credits with state support.

A more nuanced investment strategy is one that many on Wall Street are adopting amid signs that the year’s early momentum in emerging markets may be less linear ahead.

“You get the sense that a good chunk of the returns for the year may have been front loaded,” said Yung-Yu Ma, chief investment strategist at BMO Wealth Management, who remains bullish on the promise of China’s reopening. “But in terms of the trajectory, it is looking like it has a lot of runway to it.”

What to Watch

  • Investors are bracing for readings of inflation data from Brazil, Thailand and the Philippines
  • Inflation in Mexico will be closely watched ahead of a central bank meeting
    • Bloomberg Economics anticipates Banxico to slow its tightening pace and hike rates by 25 basis points to 10.75%
  • China will release CPI data on Feb. 9, offering insight as the country emerges from its Covid Zero policy
  • The Reserve Bank of India is set to raise rates, likely for the last time this cycle. The recovery is slowing, but the focus will be on cooling core inflation that remains elevated, according to Bloomberg Economics
    • Traders will continue to monitor Gautam Adani’s sprawling energy-to-ports empire

--With assistance from Farah Elbahrawy and Karl Lester M. Yap.

(Updates with decline in Asian currencies on Monday in 6th paragraph.)

©2023 Bloomberg L.P.