Fed Bounce Seen in Emerging Markets If Greenspan Is a Guide

  • Developing stocks more than tripled after 2004 rate increase
  • China's economic slowdown is a wildcard this time around

For all the concern about the effect of the Federal Reserve’s impending interest-rate increase on emerging-market equities, history suggests they’re more likely to benefit than take a beating.

When former Fed Chairman Alan Greenspan started tightening monetary policy in June 2004, the MSCI Emerging Markets Index began climbing. After keeping the target federal funds rate at 1 percent for the prior 12 months, Greenspan gradually lifted it to a peak of 5.25 percent by June 2006. Developing-nation equities had soared more than 70 percent by then and wouldn’t peak until October 2007, by which time they had more than tripled.

The positive trigger from Fed tightening didn’t just happen in 2004. In June 1999, as the U.S. raised borrowing costs to 5 percent after keeping them on hold for seven months, the MSCI index rose 19 percent by year-end.

Emerging-Market Stocks Versus Fed Funds
Emerging-Market Stocks Versus Fed Funds

While NN Investment Partners and Charlemagne Capital bet the trend will repeat itself this time around, the rally’s sustainability is less certain since the Fed no longer has as much sway-- as it did in 2008 -- over sentiment toward developing markets. Chinese policy is more of a focal point as the rout that wiped out $2.6 trillion of emerging-market capitalization since China’s yuan devaluation last month made all too clear. The MSCI gauge is down 6.8 percent since the shock Aug. 11 move, half of this year’s declines.

Once the Fed raises rates, “I expect a brief rally as the ‘news’ is finally in the market," Nathan Griffiths, a senior emerging-market equities manager who helps oversee about $1.2 billion at NN Investment in The Hague, said on Tuesday. China may be a longer-term drag on equities because it "is so much more important than the U.S. for global trade in general and emerging-markets trade in particular,” said Griffiths, who prefers shares from India and Mexico.

Less Relief

The two countries are a lot less reliant on China for their exports than peers including Russia, Brazil and South Africa, which count the world’s second-largest economy as their biggest trading partner, according to data compiled by Bloomberg. Annual economic growth in 2015 in China is forecast to slow to less than 7 percent for the first time since 1990.

The global economic picture was rosier in 2004. While the Fed was raising rates between that year and 2006, average world growth exceeded 5 percent, compared with projections for expansion of 3 percent in 2015, according to data compiled by Bloomberg.

Economists surveyed by Bloomberg News are split on whether Fed policy makers will lift rates from the zero to 0.25 percent range they’ve been in since 2008 or delay a move at their meeting ending Thursday.

Emerging-market stocks have fallen by some 20 percent since the Fed first indicated in May 2013 it would start unwinding the unprecedented monetary stimulus that had shored up demand for riskier assets. That’s pushed the average estimated-earnings valuation for emerging stocks to 11, a 28 percent discount to the MSCI World Index of developed nations.

“The markets have had almost two and a half years to get used to the idea of rates going up,” said Julian Mayo, who helps oversee about $2.3 billion as co-chief investment officer at Charlemagne Capital in London. He holds a greater percentage of Indian, Mexican, Taiwanese and Turkish stocks relative to the emerging-markets benchmark.

“You may well see an initial relief rally and then, a gradual rise over a period of time," Mayo said. "I don’t think you’re going to see markets going up 40, 50 percent as they have in the past."

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