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Market Insights

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Emerging Markets

08/26/2013

The MSCI Emerging Markets Index (MXEF) declined 2.65% this past week and is now down 11.6% for 2013. The MXEF declined on the week despite the late week stabilization for U.S. equity markets. The Russell 2000® Index (RTY) rose 1.36% this past week. There is no change to my expectation that small caps remain investors’ best source of opportunity currently.

Many have questioned me in the past few days if the current weakness in the emerging markets will spread and create a riotous environment for all global risk assets. I do not expect that to be the case, pointing to what is occurring as being similar to the mid-1990s environment for emerging market assets and developed market assets (Figure 1). If you wish to call it “decoupling,” so be it, but the developed market indices can sustain a multi-year rise, despite emerging market weakness.

What troubles emerging markets is simple, capital outflows. Rising U.S. Treasury yields, a strong U.S. dollar, and the impending FOMC taper is encouraging the return of capital back into U.S. assets at the expense of the emerging markets. Additionally, recent economic evidence suggests that Europe, in particular the all-important core, is investable once again. This equates to the grand evil of emerging markets: currency devaluation. An unfavorable environment exists in the near term for both the equity and debt markets of emerging markets.

The question becomes what happens next? There is currently no evidence that motivates me to change my cautious cyclical view for emerging markets in 2013.

Country

Currency

Month to Date

Year to Date

Mexico

Peso

-1.03%

-0.80%

Thai

Bhatt

-1.73%

-3.96%

Brazil

Real

-1.90%

-12.66%

Argentina

Peso

-2.00%

-12.59%

Turkey

Lira

-2.05%

-10.26%

South Africa

Rand

-2.64%

-17.28%

India

Rupee

-4.59%

-13.19%

Indonesia

Rupiah

-7.12%

-11.44%



Source: Bloomberg

However, I do view the current emerging market climate of cheap currencies and subsequent central bank fiscal action as laying the secular foundation for the next phase of emerging market growth. 

The existing currency environment is not the genesis of the next emerging market crisis such as occurred in the late 1990s. This is not the 1995 Mexican peso crisis or the 1997 Thai baht crisis.

2013 is not 1998

  • Commodity prices remain stable. In 1998 the price of oil wallowed below $20; today it hovers above $100.
  • Recent economic evidence is the most important, and the stabilizing, emerging market economy of China suggests a trough is in place.
  • Global currency reserves are at historic levels (Figure 2), allowing emerging market central banks to utilize their monetary reserves to support depressed currencies.
  • For example, last week Brazil put forth an intervention of $60 billion in currency swaps and loans.

Emerging market debt and equity markets, have been cyclically challenged for much of 2013, however, the secular positive trend of the past 10 years remains in place.

Figure 1 MXEF and SPX, 1994-19988-26 Joe Terranova 1.1

8-26 Joe Terranova 1.2
Source: Bloomberg

Figure 2 Global Currency Reserves
8-26 Joe Terranova 1.3
Source: Bloomberg

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