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Investors are shedding emerging market stocks as they brace for President-elect Donald Trump’s proposed trade tariffs and grapple with a rising U.S. dollar and rising bond yields.
MSCI’s emerging markets the index, which tracks nearly $7.6 trillion in stocks across China, India, Brazil, South Africa and other markets, has fallen more than 10 percent since hitting a two-and-a-half-year high on Oct. 2. Stocks in developed markets are roughly flat during this period.
Emerging markets have been hit by bets that inflationary policies like tariffs and tax cuts under Trump, on top of already buoyant economywill force the Federal Reserve to keep interest rates elevated for much longer than previously expected. U.S. Treasury yields have risen in recent weeks as traders reassess their outlook for inflation.
“It is clear with rising US yields and the strength of the US dollar. . . this is definitely not an emerging market business environment,” said Emre Akcakmak, portfolio consultant at emerging market fund manager East Capital, adding “major markets accounting for two-thirds [MSCI] indexes are all under pressure”.
Chinese stocks, which make up the largest share of the index, have fallen 15 percent since Oct. 2 amid concerns about the health of the country’s economy. India and South Korea, the other two emerging market heavyweights, have also suffered heavy losses in recent months.
Investors have pulled about $3 billion from global emerging market equity funds so far this year, on top of $31 billion in outflows last year, according to JPMorgan data.
Longer periods of higher US rates and a strong dollar tend to lead US investors to stay at home rather than take on greater investment risk abroad.
Investors are now betting that countries will try to weaken their own currencies and make their exports more competitive in response to US tariffs, a move that would reduce dollar earnings in emerging markets.
“There is a consensus that protectionism is getting worse and that America first is the only way,” said Archie Hart, portfolio manager of emerging markets stocks at Ninety One. However, he added, the markets have been pricing in turbulent trade relations for years.
Some investors are bracing for a selloff in emerging market assets in the first half of the year, followed by a recovery, on bets that tariffs will initially be set higher than Wall Street consensus, only to be reduced as Trump makes deals with individual countries.
“Right now, what we’re seeing is a very emotional, irrational reaction and so historically it has created buying opportunities,” said Kristina Hooper, chief global markets strategist at Invesco.
However, other investors are still hesitant to return to emerging markets given that it means a large underlying exposure to Chinese stocks, unless they are kicked out of the index, which can overshadow moves in other countries.
Those concerns were highlighted last week when shares of social media and gaming giant Tencent fell sharply after the Pentagon flagged it as allegedly linked to China’s military. The company makes up about 4 percent of the MSCI index, or about the same as the entire weighting of the benchmark for Brazilian stocks.
“China has just become, for many people, a bit of a pariah; it was uninvestable,” said Mark McCormick, head of foreign exchange and emerging markets strategy at TD Securities.
