Emerging Markets Volatility: A Bit of Perspective

August 16th, 2018

China, Turkey, Russia, Brazil, and Argentina are among the countries involved. Stock and bond values in these and other emerging economies have plummeted this year, prompting many to wonder: Is the danger of investing in emerging markets worth the possible return? Yes, is the quick response? While frightening, recent price reductions are not unexpected. Emerging markets have historically been associated with huge price swings, shifting political regimes, and boom-and-bust cycles.

So far in this recent downturn, the majority of the developing market volatility has been focused in a small number of markets. Consider that China, South Korea, Taiwan, India, and South Africa account for 73% of the MSCI Emerging Market Index, the most prominent stock index for emerging markets. For more context, consider how equities markets in nations that have recently made headlines affect performance on the MSCI EM Index:

Countries with Minimal Impact

Turkey [0.7% of the MSCI Emerging Markets Index]: Turkish President Tayyip Erdogan has imprisoned numerous opponents and dissenters while appointing his son-in-law as finance minister with influence over Turkey's central bank. Due to Turkey's large foreign debt - one of the highest among developing nations – and limited foreign currency reserves, investors are fleeing. While there is cause for concern, the Turkish equities market accounts for a relatively minor portion of the MSCI EM Index and does not appear to pose a significant danger of contagion to other emerging market economies.

Russia [3.5 percent of the MSCI EM Index]: The surprise imposition of new US sanctions on Russia for attempting to poison a former Russian spy residing in the United Kingdom caused a slump in the Russian ruble and stock market. Our fund managers have avoided Russia in general, with the little exposure they do have coming from Russian exporters who gain from the ruble's decline. We do not consider Russia to be a systematic risk, and nearly all of our EM managers have underinvested in the nation.

Argentina [0.0 percent of the MSCI Emerging Markets Index]: Argentina is experiencing hyperinflation and doubts about its ability to repay its debt. The country just got an IMF loan and is expected to adopt measures to decrease spending and debt. Argentina is not yet included in the MSCI Emerging Markets Index, and the EM managers in which we invest have little or no exposure to it.

Countries with Significant Impact

Brazil [6.4% of the MSCI EM Index]: Brazil’s equity market lost 26% in the second quarter, due to uncertainty about elections this fall, corruption scandals, lower growth prospects, and a falling currency which makes Brazil’s dollar-denominated debt more expensive to pay off. We believe there is now significant value in certain Brazilian market sectors, which will start to be realized once the election is over and a new government is formed.

China (31.2 percent of the MSCI Emerging Markets Index): China's economy is showing signs of instability and could deteriorate further if a full-fledged trade war with the United States occurs. This would have a big regional impact because many Southeast Asian enterprises are suppliers to China. So far, a drop in the Chinese yuan has somewhat offset the US tariffs, keeping Chinese export prices relatively stable. Furthermore, the government has offered economic stimulus by cutting short-term interest rates, which is anticipated to promote investment. Finally, we anticipate the trade conflict between the United States and China will be addressed before it causes significant harm.

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