Investors Weed Out Weakest Links in Emerging-Market Tumult
A rising dollar and higher U.S. interest rates are pressuring stocks, bonds and currencies in developing economies
As stocks, bonds and currencies in developing economies come under renewed stress from a rising dollar and higher U.S. interest rates, investors are trying to separate economies able to weather the storm from those too fragile to cope.
The MSCI Emerging Markets Index has dropped by almost a fifth since its January high, hovering on the edge of a bear market, commonly defined by a fall of 20% or more from a recent high.
“My fear of contagion is that right now the sentiment towards the whole emerging-market spectrum is very fragile,” said Mario Castro, a Latin America currency strategist at Nomura.
A common thread affecting those economies: The dollar is by far the most commonly used currency in global trade and debt markets. So when the U.S. economy looks in much better health than the rest of the world and the Federal Reserve is lifting interest rates, upheaval often follows in the developing world.
Currencies in the developing world have sold off against the dollar, led by the Turkish lira and Argentine peso, which are down by more than 40% and 50% this year. The Indian rupee reached its weakest-ever levels this week, and the Indonesian rupiah is trading at two-decade lows.
This is neither a string of unrelated blowups nor a meltdown where contagion spreads by panic selling moving from nation to nation. It is somewhere in the middle: creating both dangers and opportunities for investors.
Many markets face similar issues: While U.S. manufacturing output probably grew at its fastest in 14 years in August, according to Institute for Supply Management surveys, a poll of purchasing managers in manufacturing firms around the world, published by JPMorgan and IHS Markit , showed the slowest output growth in nearly two years.
Raw-materials prices have also faltered, with the Bloomberg Commodity Index falling 9% since its peak in May. That puts pressure on major exporters of commodities other than oil, such as Brazil, Chile and Indonesia.
Moreover, many investors buy emerging-market assets in broad funds, rather than country by country. So when they reduce exposure, developing markets can be hit all at once.
“There are a lot of people out there who are distressed sellers or forced sellers,” said Mark Tinker, head of the Framlington Equities Asia business at AXA Investment Managers.
The links extend into developed markets such as Western Europe, given the region’s lending ties to countries including Russia and Turkey and its trading ties with China.
Mr. Castro said much was riding on a presidential vote this year in Brazil that will decide whether the country enacts changes to keep its economy healthy and debt in check. “There is a lot at play in the elections, and Brazil is systemically important for emerging markets,” he said.
Money managers also say it is possible to distinguish clearly between different kinds of developing nations.
“There is a debt crisis in emerging markets. They’ve just racked up way too much debt, and those chickens are coming home to roost. But we need to differentiate clearly when we talk about these concerns,” said Bryan Carter, head of emerging-market debt at BNP Paribas Asset Management.
“You can separate almost all countries into one or two camps: the countries with central banks that have decided to keep up with the Fed and hike rates and those that have consciously decided not to,” he added.
Mr. Carter said Argentina was in the first camp. He said the country’s bonds were his largest single overweight position, based in part on the country’s orthodox economic governance. In contrast, Brazil and South Africa have allowed their currencies to take the strain, rather than raise interest rates.
Others note that China has successfully taken yet another path, amping up spending and loosening monetary policy rather than following the Fed. As a consequence, while shares have fallen sharply this year, prices of Chinese government debt have risen, sending yields lower, in contrast to other emerging markets.
“My view is that China has already become less EM-like than it was in 2016,” said Karthik Sankaran, director of global strategy at Eurasia Group. A previous growth scare gripped Chinese markets in 2015-16.
Even in more vulnerable countries, some fund managers are snapping up securities issued by companies that are stronger than their domestic economies. “You have companies in Indonesia that are very export oriented, with no foreign debt. That’s an absolute winner,” said Leon Goldfeld, a multiasset portfolio manager at J.P. Morgan Asset Management.