Emerging markets are exhibiting strong signs of growth from an economic and financial market perspective, portfolio managers said at Prudential’s Midyear Global Markets and Economic Outlook on Wednesday.

Edward Keon, portfolio manager at Quantitative Management Associates, a Prudential institutional investment company with $111 billion in assets under management, said the portfolio is overweight equities at 66% with the remainder in fixed income. “We think that investing in riskier assets make sense,” he said. “Over the past month, we have pulled back a little bit from our most aggressive positions. We have switched our equity positions, adding to emerging markets and pulling back in Europe.”

Emerging markets have rebounded, beginning with a sharp rally in March. “Earnings expectations for emerging markets have risen after a steep fall,” Keon said. “We are not aggressively overweight but are adding emerging markets positions. Emerging markets has emerged as a diversifying asset class, as emerging markets and developed markets have decoupled.”

In terms of regional outlook, “Europe represents a value stock play, the U.S. looks like a growth stock, and emerging markets have both cheaper valuations and good growth prospects,” Keon said. “Earnings expectations for the US have been rising, which is unusual. Most analysts cut forecasts as the year goes on.”

However, a change in Fed policy could come sooner than expected, Keon said. “Corrections are a normal part of market behavior. We will have one but it’s impossible to say when it will happen, but the trend in equity prices is higher.”

Barring a sustained upside surprise in growth, 2014 is shaping up to be a productive year in bonds. The combination of low growth, moderate inflation, and low short-term interest rates should continue to fuel the search for yield. The strongest returns are likely to accrue to the highest yielding sectors over the balance of the year.

“In our view, the decline in interest rates over the past 35 years is a one-time phenomenon, just like the rise in rates that occurred during the 1960s and ‘70s,” said Robert Tipp, chief investment strategist at Prudential Fixed Income, which has $418 billion in assets under management.

The past several quarters represent a transitional period for the bond market, in Prudential’s view. “In the post-bull market, range-bound world ahead, episodes like those of the past couple of years—featuring quarter-to-quarter market volatility but positive returns on fixed income over long stretches of time—are likely to be the rule, especially from the high-yield sector,” said Tipp.

“As rates fell, there was lots of financial innovation, and people could carry more debt, which led to a massive buildup in private sector debt,” Tipp added. “Then, during the financial crisis, there was massive fiscal stimulus, which created a huge overhang of public sector debt. That combined with demographic shifts will keep rates below average level, and we will continue to see a search for yield. “

John Praveen, chief investment strategist at Prudential International Investment Advisers, said that even after the Federal Reserve ends quantitative easing, monetary policy will remain accommodative. The U.S. economy will experience 3-4% growth in the second half of the year, he said, while growth in the Eurozone will expand from core countries like Germany to peripheral countries like Spain. In Japan, growth should stabilize around 2%. Emerging markets will also see stabilization and improved growth.

“Markets are not cheap, but they’re not overly expensive either,” Praveen said. “We are not in a bubble situation.”

Praveen expects global stock markets to post bigger second-half gains, fueled by improved economic growth and earnings, further central bank easing, and stabilizing emerging markets.

Emerging markets outperformed in the second quarter with a solid 3.3% gain in May, and added another 1.6% in June to take second quarter gains to 5%, Praveen said.

Featured image via madpixblue/Dollar Photo Club