Emerging markets have had a turbulent year. Valuations have tumbled, as the MSCI Emerging Markets Index fell more than 20% below its January high – after rising 34% last year – and stocks continue to dip in and out of bear-market territory.
September brought a positive close, after a bleak start to the month that was characterised by a currency crash in Turkey and South Africa falling into recession.
But the turnaround didn’t last long: the past two weeks of trading has seen the biggest sell-off in global financial markets since February this year, with emerging markets being hit particularly hard as investors’ appetite for risk increasingly closes. The MSCI EM has now fallen lower than before the partial rebound.
A variety of issues including rising interest rates in the US, escalating trade tensions between the US and China and significant currency dips in countries like Argentina, Turkey and Indonesia, have seen emerging markets dragged down through a contagion effect.
All in the red
This week sees the world’s ETFs all in the red. Nigeria and Greece are both 69% below their all-time-highs, Brazil and Vietnam are 46% and 42% lower respectively, while established but troubled Italy is an eye watering near 50% off its all-time-high.
India saw foreign investors sell $4.3bn of equities in just three weeks and China’s benchmark index fell 25%, creating a new low for the year and finishing at a four-year low. In Indonesia, the Rupiah has hit a 20-year low. The South African rand sunk to a two-week low on Thursday, and Turkey’s lira is down 34% against the US dollar this year.
Furthermore, Argentina’s peso has continued to plunge throughout the year due to a combination of high inflation rates, and it being overvalued for so long. In response to the country’s economic crisis, the fiscal deficit had widened by $621.8m on Monday.
It's no wonder that the IMF last week trimmed its 2018 global economic growth forecast by 0.2%.
The biggest winner continues to be the US. While Japan and Europe have remained relatively stable, with the exception of Italy due to recent conflict over a contentious budget, and worries about loans to emerging markets.
All eyes are on the US Federal Reserve, as the central bank continues to raise interest rates for the third quarter in a row. With a strong dollar and US unemployment at its lowest since 1969, emerging markets are becoming an increasingly unattractive space.
This week also saw US Treasury yields rise to their highest level since 2011, further attracting investors to this relative safe haven in an era of President Trump’s rising protectionist policies.
It means that China and Russia, despite being considered the least vulnerable of the emerging markets, are at growing risk from the escalating trade war.
There are also larger concerns that the current turmoil could turn into a similar crisis as seen in Asia in 1997, which was brought on by a move in foreign exchange rates that quickly turned a sustainable situation into one that wasn’t.
While investors are seeking refuge in safer assets like the dollar, emerging markets may well still have numbers on their side in the long term: Not only does 83% of the world’s population live in emerging markets – with over half being middle-class – but they account for 70% of global growth.
Even in light of fiscal excesses in Brazil, monetary excesses in places like Turkey, or perceived debt excesses in China, emerging markets have made significant progress over the last year. They’ve raised their overall GDP by 15%, and that’s just continuing on from a decade of breakneck growth.
The high risk/reward profile of owning emerging stocks may also be fostered by the US dollar being heavily overvalued, as well as the discrepancies between US and emerging market stocks, argues Adam Strauss, co-CEO at Appleseed Capital.
Indeed, by price-to-book ratio, emerging market equities are currently trading at 36% below those of the developed world. Each time since 2001, when the price-to-book discrepancy between the two has been this wide, emerging markets have gone on to outperform developed world equities by 100% in the subsequent five years, according to research by Neptune Investment Management.
It appears that emerging markets may well now be at a tipping point, it’s now just a question of whether those lows will continue or rebound.