Bernanke Speaks, and Emerging Markets Take a Hit
Markets the world over have wobbled since Federal Reserve Chairman Ben Bernanke acknowledged to Congress on May 22 that the central bank might slow down its stimulus program. No area has been hit quite like emerging markets. Seven of the 10 worst-performing stock markets since Bernanke’s testimony are based in developing countries. Brazil’s Ibovespa index has lost the most, down 21.6 percent as of June 19, and benchmarks from the Philippines to Greece have posted double-digit declines. The JPMorgan Emerging Markets Bond Index lost 7.4 percent in a little more than a month. Currencies from South Africa’s rand to India’s rupee have hit lows against the dollar. “It’s been a pretty broad beating across the board,” says Paul Christopher, chief international strategist at Wells Fargo Advisors. “The Fed opened Pandora’s box.”
Bernanke’s words came as a blow in part because the Fed had been feeding the emerging-markets frenzy. By keeping American interest rates near record lows, Bernanke’s stimulus policies have reduced the returns on safe assets such as Treasuries and encouraged professional traders to scour the globe for riskier, and potentially more lucrative, assets. His comments reminded those investors that the Fed’s easy money policies won’t last forever. On June 19, Bernanke said the Fed may start reducing bond purchases later this year if the economy improves.
The sluggishness of the global economy has also played a role. Emerging markets depend heavily on exports, often of commodities. While they were able to piggyback on “steroid-induced” growth in the developed world before the credit bubble burst, UBS strategist Bhanu Baweja wrote in a recent report, emerging markets are “today faced with a global economy in rehab.” A smaller global appetite for manufactured goods is weighing down China, which in turn is reducing its imports, much of which come from other developing nations. At the same time, Baweja says, after accounting for inflation in emerging markets and the strengthening dollar, fixed income investors are not earning anything extra for taking added risk.
Investors withdrew $4.3 billion from emerging-market bond mutual funds and exchange-traded funds in the three weeks after May 22. That was a reversal from $22 billion in inflows in the first 21 weeks of the year, according to EPFR Global. Even more, $13.6 billion, left stock funds. Bearish analysts say this isn’t the time to be putting money in: Emerging-market economies “are struggling, and they’re deteriorating as we speak,” says Rashique Rahman, co-head of foreign exchange and emerging-market strategy at Morgan Stanley.
Others argue that investors should stay the course. They point out that while this downturn is painful, it’s less severe than other episodes when concerns about debt defaults and currency devaluations triggered selloffs. “This is not Latin America in the ’80s,” says Eric Fine, a portfolio manager with Van Eck Global. “This is not Asia in the ’90s.”
And the recent troubles don’t undermine the long-term case for emerging markets, says Tom Hainlin, a strategist with U.S. Bank’s wealth management division for ultra-high-net-worth clients: These economies are growing faster than others. McKinsey forecasts emerging-market consumers will spend $30 trillion a year by 2025, as much as the rest of the world combined. The World Bank estimates a “gradual acceleration” in developing-country growth, from 5.1 percent this year to 5.7 percent by 2015.
Despite the recent losses, anyone who bought into emerging markets more than a few months ago is still sitting on gains. Over the past year, the MSCI Index is up 1 percent, and over 10 years it has climbed 203 percent. The Standard & Poor’s 500-stock index has gained 67 percent in a decade. “We’ve been trying to remind people that volatility is a natural part of the business,” says Chris Philips, a senior analyst in Vanguard’s investment strategy group. He says abandoning emerging markets now could be a mistake. “It’s almost the opposite of what you’d want to see,” he says. “You want to see investors buying now because of the valuations relative to elsewhere in the marketplace.”
If emerging markets continue to respond closely to events out of the U.S., a lasting casualty of this rout may be their appeal as a source of portfolio diversification. To find assets that zig when America zags, investors may be tempted to look even further along the risk spectrum to “frontier” markets—even less-developed nations such as Ghana and Vietnam that are new to the global economy and more insulated from the Fed’s maneuvers. The MSCI index for this group is up 11.3 percent this year.