Tempered tantrum: Why emerging markets are better positioned this time around
Author: Regina Chi
May 24, 2018
Emerging markets are in much better shape than in the past to handle exogenous shocks like the recent rise in the U.S. dollar, but the pullback in stock prices over the past few weeks is a reminder that some developing countries are better positioned than others to mitigate risk in periods of weakness.
So far in May, the MSCI Emerging Markets Index has fallen 2.4% compared to a 1.6% increase in the MSCI All Country World Index, according to Bloomberg data. The downturn follows more than two years of outperformance relative to broader global markets and can be largely attributed to the break above 3% in 10-year U.S. treasury yields and subsequent strength in the greenback.
To some extent, these losses are reminiscent of the Taper Tantrum set off by former U.S. Federal Reserve Chairman Ben Bernanke’s speech on slowing the pace of bond purchases in May 2013. In both cases, the primary concern of investors has been emerging nations with large current account deficits and their ability to service U.S. dollar debt when borrowing costs become more expensive (via higher U.S. interest rates and/or U.S. dollar).
Back then, however, there were far more countries to worry about than now, highlighted by the so-called “Fragile Five” of Turkey, Brazil, India, Indonesia and South Africa. As a whole, emerging market nations have improved their current accounts by almost 1 full percentage point in the past five years and, excluding China, the average current account in relation to GDP has climbed into positive territory versus a negative reading (see chart).
Thailand offers a good example of this improvement, turning its shortfall into a current account surplus of more than 10% of gross domestic product, but Brazil and South Africa are also notable for having reduced their deficits substantially in the past five years.
As a result, these countries are holding up better during the current pullback than they did in 2013 and are suffering less on average than the likes of Turkey and Argentina, who have current account deficits at more than 5% of GDP, the widest of any in the Group of 20 emerging market nations, according to data from the International Monetary Fund.
Other laggards have been oil importing nations, including Indonesia and India whose current account deficits are being threatened by the fast rise in Brent crude prices above US$70 a barrel. Not surprisingly, countries with surpluses such as China and Korea have outperformed during the selloff.
Ultimately, the current underperformance in emerging markets should prove less painful than the Taper Tantrum of 2013, particularly for investors who shy away from countries with higher current account deficits.
And while that doesn’t presume an end to the losses just yet, EM stocks are now trading at a 23% discount to global equities on a price/earnings basis, representing a potentially good buying opportunity for those ready to jump back in.
Regina Chi is a vice president and portfolio manager at AGF Investments Inc. She is a regular contributor to AGF Perspectives.