Emerging markets are threatening to drag everybody down with them ' kicking and screaming
Emerging markets have proved they still have the power to shock. The asset class has not been in the news for some time, but recent developments suggest that those who always warned of the dubious quality of 'sub-merging' investments may be vindicated. This time, far from sinking quietly without trace, the sector is threatening to drag others down with it.
Following the last major emerging markets collapse in 1998, many governments learned some painful lessons, instituting reform programmes and building up foreign exchange reserves. But last year, they were again hit as Nasdaq went into freefall, provoking fears of a sharp slowdown in the US generally. International investors did not pause to make any fine distinctions between the tryers and the non-achievers among emerging markets. The 'flight to quality' became a stampede.
With the series of US rate cuts this year, sentiment steadied a little. Turkey muddled through a banking crisis, and the fallout from Argentina's problems was contained within the region. Asian stock markets appeared to offer good value when there was little to inspire and much to worry about in home markets.
Marketing campaigns highlighed the opportunities available in an asset class that had almost fallen off the global investment radar screen. The more positive outlook depended on the early pick-up in the US. A 'V'-shaped recovery was expected, even into the second quarter of this year. But as this failed to materialise, projections were revised to a 'U'-shaped curve in the second half of 2001. Now, even that is being questioned.
A turnaround in the US before year end would be a bonus, but it might arrive too late to put off the coming storm. Volatility in bigger markets is again rocking smaller ones. The summer break is an extra hazard. Traders are at their desks while policymakers are generally on holiday and, in the absence of any official guidance, they assume the worst. Previously discounted factors suddenly acquire renewed (negative) force.
Once again, it is threatened debt default in Argentina and the looming collapse of the peso currency's peg to the US dollar, which have inflamed fears of a meltdown in emerging markets. Brazil has been punished and Mexico, which is trying to restrain its strengthening currency, has been shaken.
Contagion from Latin America, most immediately visible in the widening spreads of local debt over US Treasuries, has quickly spread to Russia and other emerging markets, some of whom have worked hard in the last 10 years to shed the second-class tag. Poland, Hungary and Turkey like to consider themselves Euro-members-in-waiting. They do not need a currency crisis as they prepare their entry bids.
It is tempting to consign the latest bout of turbulence to the 'any other business' slot at the end of the investment agenda. But in an increasingly global market, non-correlation is not what it used to be. Investors who consider themselves 'risk averse' by selling foreign holdings and buying the home market index might have to think again.
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