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Investors are ditching emerging market stocks as they brace themselves for president-elect Donald Trump’s proposed trade tariffs and contend with a soaring US dollar and rising bond yields.
MSCI’s emerging markets index, which tracks nearly $7.6tn in stocks across China, India, Brazil, South Africa and other markets, is down more than 10 per cent since hitting a two-and-a-half-year high on October 2. Developed market stocks are roughly flat over that period.
Emerging markets have been hit by bets that inflationary policies such as tariffs and tax cuts under Trump, on top of an already buoyant economy, will force the Federal Reserve to keep interest rates elevated for much longer than previously anticipated. US government bond yields have shot higher in recent weeks as traders reassess their outlook for inflation.
“It’s clear with US yields rising and the US dollar strength . . . this is definitely not an environment for emerging markets to perform,” said Emre Akcakmak, portfolio consultant at emerging markets fund manager East Capital, adding “the major markets that are accounting for two-thirds of the [MSCI] index are all under pressure”.
Chinese stocks, which make up the largest share of the index, have dropped 15 per cent since October 2 on concerns about the health of the country’s economy. India and South Korea, two other emerging market heavyweights, have also sustained steep losses in recent months.
Investors have pulled about $3bn from global emerging market equity funds so far this year, on top of $31bn in outflows last year, according to JPMorgan data.
Longer periods of higher US rates and a strong dollar usually entice US investors to stay at home rather than take more risk investing abroad.
Investors are now betting countries will try to weaken their own currencies and make their exports more competitive in response to US tariffs, a move that would depress emerging market dollar earnings.
“There is a consensus case that protectionism gets worse and that America first is the only way,” said Archie Hart, emerging market equities portfolio manager at Ninety One. However, he added that markets had already priced in stormy trade relations for years.
Some investors are positioning for a sell-off across emerging market assets in the first half of the year, followed by a rebound, in a bet that tariffs will be initially set higher than the Wall Street consensus, only to be reduced as Trump strikes deals with individual countries.
“Right now, what we’re seeing is a very emotional, irrational reaction and so that has historically created buying opportunities,” said Kristina Hooper, chief global markets strategist at Invesco.
However, other investors are still reluctant to jump back into emerging markets given this means a large underlying exposure to Chinese stocks, unless they screen them out of indices, which can overshadow moves in other countries.
Those concerns were underlined last week when social media and gaming giant Tencent’s shares fell sharply after it was designated by the Pentagon as having alleged Chinese military links. The company makes up about 4 per cent of the MSCI index, or about the same as the benchmark’s entire weighting for Brazilian stocks.
“China has just become, for many people, a bit of a pariah; it’s been uninvestable,” said Mark McCormick, head of foreign exchange and emerging markets strategy at TD Securities.
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