China’s economic struggles aside, emerging markets aren’t faring so badly

Nicholas Spiro says the poor performances of emerging markets are largely due to a handful of examples, like Turkey and Argentina’s collapsing currencies and China’s trade-war-driven slowdown. Others, like India, Taiwan and especially Mexico, have displayed strength

PUBLISHED : Monday, 03 September, 2018, 2:18pm
UPDATED : Monday, 03 September, 2018, 10:36pm

The sell-off in emerging markets shows no signs of abating. Last Thursday, Argentina, one of the most vulnerable developing economies, was forced to raise its main interest rate to 60 per cent in a desperate attempt to arrest the plunge in its currency, the world’s worst-performing this year. The wilting Turkish lira, meanwhile, fell almost 9 per cent last week.

Both countries’ woes are contributing to the strain on other emerging market currencies which, according to a new report from Ashmore, an asset manager, have entered their most volatile phase since the global financial crisis.

Investor sentiment towards developing economies was also undermined by reports that US President Donald Trump wants to move ahead with plans to impose tariffs on an additional US$200 billion of Chinese imports, further escalating a trade war that threatens to depress global growth.

Add in the sharp rise in the US dollar since April, stemming mainly from the more hawkish policies of the Federal Reserve, and steep falls in industrial metals prices over the past several months, and the scope for further outflows from emerging market funds is considerable.

The selling pressure is fiercest in equity markets, mainly because of the heavy weighting of China in the benchmark MSCI Emerging Markets Index. Not only does the world’s second-largest economy account for 31 per cent of the gauge, Chinese companies make up nearly 45 per cent of the popular information technology subindex, which itself has a more than 27 per cent weighting in the broader index.

The 12.1 per cent drop in US dollar terms in the China component of the index over the past three months – a decline more or less on a par with the fall in the CSI 300, a leading gauge of mainland stocks – has been the key factor behind the nearly 6 per cent decline in the broader gauge. If China is excluded, emerging market shares have fallen only 2.6 per cent since the end of May, just before the trade dispute escalated sharply and the yuan began its steep decline against the dollar.

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Indeed, the drop in the MSCI Emerging Markets ex China Index in the past three months is comparable to the fall in the FTSE 100, Britain’s leading stock gauge, and is less than half the decline in the FTSE MIB, Italy’s main equity index.

What is more, many leading emerging markets have delivered positive returns, including several in Asia, the region with the strongest economic and financial linkages with China. The equity markets of Poland, Hungary, the Czech Republic, Malaysia, the Philippines, India and Taiwan (the latter two account for over a fifth of the benchmark index) have all risen since the end of May and have outperformed the Stoxx 600, Europe’s main equity index.

In the strongest sign that the sell-off in China is not proving contagious, the IPC Index, the main equity gauge in Mexico – the country that has the most to lose from the protectionist policies of the Trump administration given that America accounts for some 80 per cent of Mexico’s exports – has shot up 11 per cent since the end of May. Mexican assets are benefiting from market-friendly rhetoric from the country’s new left-wing president and last week’s signing of a bilateral trade deal between the US and Mexico.

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Global equities, moreover, are being buoyed by the remarkable recovery of US stocks, with the benchmark S&P 500 index hitting a series of fresh highs last week and enjoying its best return in August since 2014 and its calmest August since 1967, according to data from Bloomberg.

If anything, the renewed turmoil in China’s markets is perceived by international investors as another reason to load up on US equities, which are underpinned by a strong economy and spectacular earnings growth.

This all stands in stark contrast to the China-induced panic in January 2016 when global stocks were convulsed by fears about financial stability in the world’s second-largest economy.

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While this is mostly due to the fact that, unlike in 2015-16, investors currently see little risk of a disorderly depreciation in the yuan, it is also attributable to the increasingly attractive valuations of Chinese stocks – and emerging market shares more broadly – following months of steep declines. JPMorgan notes that emerging market equity valuations and earnings growth are much lower than at the start of this year and provide “a much better entry point for the resumption” of a rally.

Still, a meaningful and sustained improvement in sentiment hinges critically on a de-escalation in trade tensions which, for the time being, appears unlikely. With China accounting for nearly a third of the MSCI emerging markets index, the scope for contagion should trade tensions intensify should not be underestimated.

Nicholas Spiro is a partner at Lauressa Advisory