Emerging Markets Volatility: A Bit of Perspective
China, Turkey, Russia, Brazil, Argentina. Stock and bond prices in these and other emerging markets are down dramatically this year, leading many to ask: Is the risk of emerging markets worth the potential return? Our short answer is: yes. While scary, the recent price drops are not unusual. Emerging markets have long been associated with wild price swings, shifting political regimes, and periods of boom and bust.
In this recent downturn so far, most of the emerging market volatility has been concentrated in relatively few markets, and those markets are relatively small. Consider that 73% of the most popular stock index for emerging markets — the MSCI Emerging Market Index — is comprised of five countries: China, South Korea, Taiwan, India, and South Africa. For some perspective, here is how equity markets of countries recently in the news impact returns on the MSCI EM Index:
Countries with Minimal Impact
Turkey [0.7% of the MSCI EM Index]: Turkish President Recep Tayyip Erdogan has jailed many rivals and dissenters while making his son-in-law finance minister with control over Turkey’s central bank. Investors are fleeing due to Turkey’s high foreign debt — one of the highest among developing economies – and minimal foreign currency reserves. While there is great cause for concern, the Turkish equity market is a very small part of the MSCI EM Index and does not appear to present serious contagion risk to other emerging market economies.
Russia [3.5% of the MSCI EM Index]: New US sanctions against Russia for attempting to poison a former Russian spy living in the UK were unexpected, causing a drop in Russia’s currency and stock market. Our fund managers have stayed away from Russia, in general, with the little exposure they do have coming from Russian exporters that benefit from depreciation of the ruble. We do not view Russia as a systematic risk, and almost all our EM managers have underinvested in the country.
Argentina [0.0% of the MSCI EM Index]: Argentina is experiencing hyperinflation and concerns about its ability to pay back its debt. The country recently received a loan from the IMF and is likely to implement reforms to reduce expenses and pay down debt. Argentina is not yet part of the MSCI EM Index, and the EM managers we invest in have very 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% of the MSCI EM Index]: China’s economy is showing some weakness and could weaken further should a full-blown trade war with the US occur. This would have a significant impact across the region since many Southeast Asian companies are suppliers to China. So far, a slide in the Chinese yuan has partially offset the US tariffs implemented, keeping the prices of Chinese exports fairly steady. Further, the government has provided stimulus to the economy, including lowering short-term interest rates, which is likely to stimulate investment. Ultimately, we believe the US-China trade dispute will be resolved before it does major damage.