Investment Clock insights

Soggy summer for emerging markets but Wall Street is still riding high


Trevor Greetham

6 September 2018

It has been a soggy summer for emerging markets with apparently country-specific issues in Turkey, Argentina and South Africa dragging equity markets lower. We see these pockets of financial stress as symptoms of a broader malaise for less developed economies. China is slowing down while a strong US economy means US interest rates are rising and the dollar is strong. This is a bad configuration for a wide range of emerging markets, many of which rely on US dollar capital to support their economies or export commodities to China.
It’s not surprising that emerging market currency volatility has spiked (dark purple line in chart 1). Currency volatility for the G7 group of developed countries has remained muted and US equity market volatility is low, however, indicating a lack of contagion to other parts of the world. In fact, our US equity investor sentiment indicator has moved towards euphoric territory with US retail investors bullish and US company directors buying fewer shares in their own companies than usual as prices rise (chart 2). 
This divergence between developed and emerging markets is similar to what we saw in the 1990s. Back then a slowdown in Japan kept inflation low, allowing G7 monetary policy to stay loose for years and boosting developed market growth. Until it all ended in the dotcom bubble. This time around, a slowdown in China has kept interest rates around the world even lower than in the 1990s and technology stocks are surging again. 
Despite the parallels, it’s too early to worry about a serious economic downturn in developed economies, in our view, despite signs of a slowing in economic momentum. The US Federal Reserve is raising interest rates but only very gradually while central banks elsewhere are in no hurry to tighten policy. President Trump has only recently eased fiscal policy. Against this background, we expect the economic expansion to continue into 2019 and we’d be willing to buy dips in equity markets while remaining overweight Wall Street versus the emerging markets in our regional equity allocation.

It has been a soggy summer for emerging markets with apparently country-specific issues in Turkey, Argentina and South Africa dragging equity markets lower. We see these pockets of financial stress as symptoms of a broader malaise for less developed economies. China is slowing down while a strong US economy means US interest rates are rising and the dollar is strong. This is a bad configuration for a wide range of emerging markets, many of which rely on US dollar capital to support their economies or export commodities to China.

It’s not surprising that emerging market currency volatility has spiked (dark purple line in chart 1). Currency volatility for the G7 group of developed countries has remained muted and US equity market volatility is low, however, indicating a lack of contagion to other parts of the world. In fact, our US equity investor sentiment indicator has moved towards euphoric territory with US retail investors bullish and US company directors buying fewer shares in their own companies than usual as prices rise (chart 2). 

This divergence between developed and emerging markets is similar to what we saw in the 1990s. Back then a slowdown in Japan kept inflation low, allowing G7 monetary policy to stay loose for years and boosting developed market growth. Until it all ended in the dotcom bubble. This time around, a slowdown in China has kept interest rates around the world even lower than in the 1990s and technology stocks are surging again. 

Despite the parallels, it’s too early to worry about a serious economic downturn in developed economies, in our view, despite signs of a slowing in economic momentum. The US Federal Reserve is raising interest rates but only very gradually while central banks elsewhere are in no hurry to tighten policy. President Trump has only recently eased fiscal policy. Against this background, we expect the economic expansion to continue into 2019 and we’d be willing to buy dips in equity markets while remaining overweight Wall Street versus the emerging markets in our regional equity allocation.

Chart 1: EM & G7 FX Volatility and VIX 

Source: Bloomberg as at 03/09/2018

Chart 2: Investor Sentiment and Global Stock Prices

Source: Thomson Reuters Datastream as at 31/08/2018

Past performance is no guide to the future. The value of investments and the income from them is not guaranteed and may go down as well as up and investors may not get back the amount originally invested. The views expressed are the author’s own and do not constitute investment advice.