The US bourse is set to open higher as European leaders get ready to meet.

Wall Street’s biggest banks are warning that last year’s slump in emerging market assets, which left equities in these countries trailing shares in advanced nations by the most since 1998, will prove more than a fleeting sell-off.

Goldman Sachs is advising investors to cut allocations in developing nations by a third, forecasting “significant underperformance” for stocks, bonds and currencies over the next 10 years. JPMorgan Chase expects local currency bonds to post returns of just 10 percent of their annual average since 2004 in the coming year, and Morgan Stanley expects the Brazilian real, Turkish lira and Russian rouble to extend declines after falling as much as 17 percent last year.

While Brazil, Russia, India and China delivered outsized returns and symbolised the rising power of the developing world during the global financial crisis, Morgan Stanley says some of those nations may be laggards as the US Federal Reserve scales back unprecedented stimulus and interest rates rise.

“The world not long ago was so mesmerised by the emerging markets without distinguishing the good from the bad,” Stephen Jen, a partner at SLJ Macro Partners who predicted the sell-off in developing nations last year, said last month.

“The cost of capital will start to normalise and that’s when we see the truth being revealed in these markets.”

Emerging market local-currency bonds returned 205 percent in dollar terms in the decade up to the end of 2012, compared with a 58 percent gain for US treasuries, according to data compiled by JPMorgan and Bank of America. The MSCI index of emerging market stocks advanced 261 percent in that time, outpacing the 69 percent rally in the developed market measure.

Last year domestic bonds in developing nations lost 6.3 percent, the most since 2002 when JPMorgan started compiling the data. The MSCI emerging market equity gauge declined 5 percent, compared with a 24 percent rally in MSCI’s world index, the biggest underperformance in 15 years.

“It’s a structural de-rating that’s taking place” in emerging markets, Deutsche Bank strategist John-Paul Smith said last month.

Developing nation stocks would trail their peers in advanced economies by a further 10 percent this year, he said.

The recovery in developing economies, which has contributed 65 percent of global growth since 2010, is struggling to build momentum as exports grow at the slowest pace in four years. China, which buys everything from Brazil’s iron ore to Chile’s copper, faces the threat of bank failures as local government debt has risen 20 percent a year since 2010.

While emerging markets are still growing faster than developed economies, Credit Suisse forecasts the margin will shrink this year to the smallest since 2002. The growth rate in advanced economies will almost double to 2.1 percent this year, while emerging markets expand 5.3 percent, compared with 4.7 percent last year, it says.

Morgan Stanley labelled Brazil, India, Indonesia, South Africa and Turkey as the “fragile five” in August, because of their reliance on foreign capital.

Investors could still find value in developing nations if they differentiated economies based on growth momentum, inflation and balance of payments, Oppenheimer Funds asset manager Sara Zervos said.

“There will be a competition for marginal capital flows,” Zervos said last month. “There will be winners and losers.”

Investors should favour the Mexican peso, South Korean won and Indian rupee, while avoiding the rand, real and Indonesian rupiah, she said.

Aberdeen Asset Management and HSBC Asset Management said valuations in some developing nations were becoming attractive after the recent sell-off.

“When people are running away, we are happy to get in,” HSBC Asset Management debt manager Guillermo Osses said last month. Osses said he was buying the currencies and short-term debt in Brazil and South Africa following their slumps. – Bloomberg