Emerging market equities are outperforming stocks in developed economies this year, but the trend could be short lived, Geoff Dennis, head of global emerging market equity strategy at UBS, warned on Wednesday.
Since late January, emerging market stocks have rallied about 15 percent as the dollar has weakened and commodity prices have rebounded, Dennis noted.
But UBS is not expecting the greenback to remain persistently weak, and does not think emerging market currencies have bottomed.
“This is just a temporary trend, so we’re not really chasing this rally aggressively in emerging markets,” Dennis told CNBC’s “Squawk Box.””In fact we’ve had a number of these rallies and then big selloffs in the last five years, and I think this is just another one of those.”
In dollar terms, emerging equities have fallen by 31 percent, with earnings per share down 29 percent, over the course of the last five years through 2015, according to UBS research. In that same period, the trade-weighted dollar index is up 33 percent.
While dollar weakness can provide a boost to emerging market stocks, the real trigger is improved earnings, Dennis told CNBC.
“I think what the markets have done in the last few weeks is assume the global economy is OK, and no major central bank will ever raise interest rates again, whereas it’s very clear at some point the Fed’s going to come back on the scene, and when that happens, the dollar is going to go back up against emerging market currencies,” he said.
In order to continue outperforming, emerging markets need a “Goldilocks”‘ scenario in the United States with weak but not too weak growth, and little to no additional interest rate hikes following the Fed’s initial 25-basis point increase from near zero in December, Dennis said.
More likely there is more weakness to come in key currencies, including the Brazilian real and the South African rand, he said.
UBS does believe the dollar will fall toward 1.16 against the euro on the view there is a greater chance that positive growth surprises will emerge in Europe than in the United States.