Analyzing the emerging markets rout

Spearhead Analysis – 04.02.2016

By Hassaan Khan
Research Analyst, Spearhead Research

global_recession_risk2016 has kicked off with a $2.3 trillion rout in emerging markets stocks. Emerging markets are experiencing the worst start to a year on record with at least twenty six emerging/frontier markets entering bear territory. Fuelling this rout has been the continually weak data from China, where the currency volatility and the lowest level of GDP growth since 1990 has resulted in a decreased valuation of the domestic stock market by at least $4.3 trillion. This reduced valuation when taken with the weaker than expected Purchasing Managers’ Index has translated to lower demand from China for commodities. This in turn has had a domino effect on commodity centric economies Brazil and Russia.  Russia’s economy has contracted by 1.7% last quarter and Brazil is on the precipice of an outright depression. The uncertainty surrounding oil has not helped the matter and has only added fuel to this contagion with oil producing nations facing a liquidity crunch resulting in sovereign funds withdrawing their investments to keep their operations going.

Emerging-StocksThe figure on the left shows MSCI Emerging Markets Index is at its lowest since May 2009 and also shows that while the new-year has been hard for markets across the board, it has been especially hard on emerging markets.

Investors worldwide including the legendary investor George Soros have voiced their concern that this might just be the beginning as China may be in for a hard landing. In addition to all the fears from China, the Argentinean Central Bank’s decision to abandon its program of intervening in the foreign exchange market which has led to a selloff that has resulted in the peso falling by twenty percent against the dollar. The peso is not alone in losing its value and is joined by the South African Rand, Brazilian Real, Russian Ruble and Turkish Lira which have also hit multi-year lows.  The currencies rout is also a developing story with the US Federal Reserve intent on hiking rates even further a further depreciation of emerging market currencies is soon to follow.

It is because of the foreign selling that is at the root of the widespread rout and so it is pertinent to know the predominant mechanism through which most foreign investors invest in emerging markets. Rarely do investors buy a particular stock as rather the methodology employed by foreign investors is a top down approach whereby after analyzing macro factors invest their money by buying exchange traded funds which are made to track the country’s or countries respective indices and so when they buy they buy a small piece of everything and conversely when they sell they sell a piece of everything.

After understanding this mechanism one does get the sense that rather than a recession the current economic situation might be more representative of a shift in the status quo because at the root of the problem is the slowdown in China and the developed world. Already we have seen a shift in economic and political power from oil exporting countries to oil importing countries and although the steep fall in the price of oil has come with its fair share of problems the undoubted benefit to consumers and industry alike will be beneficial to the economy over the long run.

To make a prediction regarding the future of the economy is however as impossible as ever but what is certain that at the end of 2016 we will see a new economic order with the previous era dominated by OPEC and China near its end. Perhaps we might see a reduction in the disparity of economic strength or even a further concentration of wealth in the hands of a few but whatever happens 2016 will be a year to watch as the new normal emerges.