We’ve said for quite some time now that it probably isn’t entirely rational to think that emerging market anything can continue to perform the way it has YTD.

This was already a tenuous situation. You’ve got an EM complex that’s managed to shake off the beginning of what’s supposed to be a Fed tightening cycle and on top of that, we recently experienced a bout of metals mayhem and commodities carnage tied to China’s efforts to deleverage their financial system.

That leads directly to one of the most important questions facing markets today: how long can a priced-to-perfection EM complex hold up in the face of a deleveraging push in China that’s almost sure to dent the country’s economic prospects and is exceedingly likely to burst bubbles that have been inflated by the rampant proliferation of shadow credit?

Or, more simply, with the Fed looking to hike and with commodities on shaky footing (“hope” around the OPEC cut extension notwithstanding), is it reasonable to assume that EM can continue to outperform even as China puts the brakes on credit expansion?

Probably not. And especially not if something goes wrong we didn’t expect. Something like another corruption scandal in Brazil that causes the real to have to its worst day since the crisis and triggers so much carnage in Brazilian equities that the Bovespa circuit breakers were tripped.

That said, a weaker dollar and falling yields in the US certainly help the bull case as does low USDCNH vol.

Well, count Goldman among those who think this should all be fine. Here’s their take, out minutes ago:

Brazilian assets sold off materially last week, but MSCI EM was down less than 1% on the week in dollar terms. However, given the uncertainty and the sell-off, do we still like EM assets in a global portfolio, particularly relative to DM? Our answer is generally yes. We continue to see the case as good for EM assets, both from a valuation and a growth perspective. The recent inflection in growth differentials between EM and DM, and our forecast for further widening in that differential from here (particularly in EM ex-China), is supportive for the EM vs. DM assets view on a medium- to long-term basis as our EM team has highlighted in the past. In addition, valuations in emerging market assets appear cheaper in EM relative to DM.

After the move in Brazil last week, our EM strategist argued that the backdrop remains supportive for EM assets broadly, but argued for a diminished alpha story in Brazil near-term given a cloudy domestic outlook. Our EM economist argued that once the dust settles, the ‘good carry’ EM currencies (RUB, INR, IDR, ZAR, COP, MXN) can outperform again.

Also, last week our rates team scaled back their yield expectations, now forecasting 10-year US Treasuries at 2.75% at year-end. Two weeks ago our FX team shifted to an expectation of less momentum in the USD strength story. While we see the growth narrative as key, both of these expectations should also provide further tailwinds to EM assets. Data based on May 19, 2017 market close.

Take that for whatever it’s worth, but do note that this is a crowded fucking trade thanks to the allure of carry in a low vol world:

(Deutsche Bank)

Finally, here’s Bloomberg’s Cameron Crise with a bit more color:

Calling market tops is a tricky business. While the movies might depict a trader reaching a sudden decision and screaming “sell it all here!”, reality is much more prosaic. Managing a portfolio is about assessing the balance of probability and deploying market risk when the odds are in your favor. The denouement is rarely as dramatic as the silver screen would have you believe.

• While I have been nervous about an interim correction in risky assets recently, let’s make one thing clear: I do not know with certainty whether a top is in, and neither does anyone else. All we can do is weigh the factors that we believe drive markets and let the chips fall where they may.
• Of course, not everyone gives various factors the same weight; as the old saying goes, that’s what makes a market. When I look at the real earnings yield of the S&P 500, I cannot say for certain that it’s at a level that will trigger a correction; I can say, however, that in broad terms it is less supportive of equity prices than it has been in quite some time.
• Making an investment case, whether bullish or bearish, is all about lining up arguments, subjecting them to scrutiny, and seeing how many remain standing. In Asia, for example, Chinese industrial commodity prices appear to have stabilized, removing an argument (if only temporarily) from the “sell EM” thesis.
• If Asian equity markets have been the driving force of the EM renaissance this year, then currency markets have been the engine room. While the KOSPI is up 22.5% this year in dollar terms, nearly 9% of it has come from an appreciation of the won. Judging the outlook for local currency performance is therefore an important component of getting the overall call right.
• It looks like we’re close to “put up or shut up” time for the won. It is now at a level versus the Chinese yuan that has held ever since the financial crisis. If history is a guide, then the Korean currency should weaken, perhaps encouraging some profit-taking in broader EM asset markets.
• If it keeps going, however, then the likely conclusion is that something significant has changed. When that happens, it’s usually time to go back to the drawing board and reassess the balance of probability. I never see that scene in the movies!