The chaos in emerging market stocks, bonds, and currencies this summer has been stunning.
But the warning signs have been out there for years. And many emerging market experts are surprised at how slow investors have been to realise this.
Here’s Citi Emerging Markets strategist Markus Rosgen in a note to clients last week:
“It is clearly a slow news summer. No A, B or C list movie star is making a fool of themselves, parliaments are in recess, heads of government on holiday, so nothing substantive to report on. Newspapers still have to go to print and attract readers’ interest, and the same goes for the financial newswires. And so for some reason, EM has become top of the headlines. That’s not to say that some EM countries haven’t got their work cut out. But in many cases, some of these issues have been well known for quite a while — current account (CA) deficits tend not to appear overnight, unlike measles, nor do overvaluations or crowded trades”
Wells Fargo’s John Silvia charted the evolution of those current account deficits for the four worst performing EM currencies this year. Like Rosgen said, it’s an old story:
“The weakness in EM currencies the past two months is not simply a consequence of rising US rates,” said Morgan Stanley’s Jason Draho. “The weakness has been happening over the past two years, and reflects broader EM structural problems.”
Here’s Draho’s chart of EM currencies falling against the dollar:
And slowing growth hasn’t helped.
Here’s a look a look at GDP growth at the largest emerging markets from Barclays. Growth has been trending down.
Industrial production confirms the weak GDP.
All of the deceleration has translated into slowing Emerging Market earnings, have trended down with most of the developed world:
And weakening profits have been bad for stocks.
Indeed, this next a chart from from Deutsche Bank’s Priyal Mulji and John-Paul Smith shows how EM stocks have underperformed developed market stocks for years.
“Except a short patch during the financial crisis of 2007-8, the period from end-2010 to present marks the only episode during which EM equities have consistently underperformed for over 10 years,” wrote Mulji and Smith. “The EM underperformance gap versus DM has persistently widened over 2013.”
If there were a catalyst for the bleeding, it was the Federal Reserve’s talk about tapering quantitative easing, which marked the beginning of the Treasury market sell-off. Below is a chart of the U.S. 10-year yield and emerging market fund flows from Barclays’ Christian Keller and Koon Chow.
But even the rise in rates has been expected widely for a while.
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