Emerging market equities have had a strong 2017 so far, up 10% points more than developed markets this year by comparison – helped along by the obvious turnaround in sentiment towards China. But in the last few weeks we’ve also seen some worrying signs that the huge flow of money into emerging markets might be slowing down, prompted in part by weakness in EM indices. The MSCI EM index was down 50bps last week, having fallen over 3% the week before and according to analysts at SocGen EM as an asset class has now broken its 2107 upward trend.

It’s a similar cautious message from analysts at UBS  – they’re tracking recent funds flow data which also suggests that investors are becoming much more cautious. Last week the bank’s analysts observed that cumulative YTD inflows to EM funds fell back to just under $60bn, “as the recent slowdown of inflows continues. This 2017 run-rate has now fallen 2% below that of 2009, as well as the record year of 2010; the gap with 2010 itself is now up to 29% “.

According to UBS and EPFR Global, GEM equity funds reported outflows of $389m last week after two weeks of above-average inflows. “This was also the first week of outflows since end-October; to end a five-week inflow streak. However, given the scale of the recent pullback in EM (-5% since 22/11), this outflow may be seen as small. Asia ex-JP funds had the biggest outflows last week ($201m), followed by $171m leakages from the Dedicated GEM funds; both also appear small relative to the inflows that these fund types received in the prior few weeks. EMEA funds (-$100m) saw a fourth week of $100m leakages.”

Investors seem to be most focused on withdrawing money from actively managed non ETF funds – by comparison ETF fund flows still look resilient. Outflows from EM non-ETF funds (-$1.1bn) surged to their highest level since the last week of 2016, says UBS, fully reversing the big inflows of two weeks ago. By contrast “EM ETFs had solid inflows ($695m), although this was just over a third of the prior week’s print. Across non-ETF funds, only LatAm funds had modest inflows ($24m) with all other regions and Dedicated GEM funds seeing outflows. In the EM ETF space, only EMEA funds (-$18m) were slightly in the red as all other fund groups reported inflows.”

What’s driving these recent zig-zag moves in EM indices? According to SocGen the weak dollar has been driving the EM vs DM outperformance. According to Andrew Lapthorne at SG “ this can be shown by comparing an equal-weighted developed market index in local currency terms against an equivalent index for emerging markets. As we show that there is little difference between the two and also shows evolving weakness in EM recently”.

Another factor worth watching out for is the quality of EM balance sheets – most of the sell-off has been in those corporates with the weakest financials. According to SocGen these “typically lower quality stocks (as measured by Merton’s distance to default) had been performing strongly for most of this year, having at one stage been up by 30%, ytd (in contrast to their weakness in the US), but have now fallen 8% in a month. This is hardly a disaster yet, but with balance sheet related problems and events becoming more common across the newswires, this is certainly one to watch, as stronger (or indeed no longer falling) US dollar and Emerging Market debt problems often go hand in hand”.

But it’s not all doom and gloom for emerging market stocks as we finish 2017. China plays a crucial role in EM sentiment and according to analysts at HSBC market sentiment in China has been broadly stable over the last three months. The global bank monitors this via their own Chinese metrics (which includes a Chinometer), notably an ECC temperature gauge. According to HSBC “ the latest reading is only marginally above the reading captured three months ago, but is higher than the year start reading, showing a positive trend. The reading was up because of improving valuation ratios, but was partly offset with a drop in the relative optimism of sell-side analysts. The key point on sentiment is that on the China theme it remains below average levels and a long way below the ‘too hot’ territory that we got to in 2011.”

The bank also reports that “anecdotally, the bottom-up message from companies on China is becoming more positive. Of the 28 companies we monitor that together form the Chinometer, 18 have recently made generally positive comments versus only 1 negative comments, and 9 mixed/no comments”.