China Crisis Infects Other Developing Markets
Currency turmoil spread across emerging markets this week, following Chinas devaluation of the renminbi, with investors panicking that a rise in US interest rates could make it tough for the developing world to repay dollar-denominated debt.
Chinas surprise move prompted by a deceleration of economic growth has not only impacted emerging market currencies but also bodes ill for economies such as Russia, Kazakhstan and Turkey which have prospered on the back of Chinas voracious demand for commodities.
With an estimated $1tn of investment outflows from emerging markets over the past 13 months, according to research by NN Investment Partners, investors are in flight from the sector. A group of 162 fund managers surveyed by Bank of America Merrill Lynch have moved their so-called underweight positions on emerging markets to a record level, meaning they are more pessimistic about this asset class than at any point the bank has documented.
The MSCI Emerging Markets stock index is trading at its lowest since May 2011, and the sell-off in equities is contributing to a currency rout, with the same compilers EM currency index having fallen to its weakest point since June 2010 as countries face mounting refinancing bills as the value of the dollar rises.
Brazils Ibovespa equity index has lost 15 per cent of its value in just three months, while Hong Kongs Hang Seng Index has tumbled 18 per cent lower.
Fear is feeding on itself, said Sean Darby, global equity strategist at investment bank Jefferies, of this weeks events.
Nick Price, emerging markets portfolio manager at investment house Fidelity, said the fear was warranted.
Chinas economic growth since the global financial crisis has been underpinned by high government investment in infrastructure, said Price, adding that this created artificial demand for raw materials produced by nations such as Chile (copper), Malaysia (oil) and Brazil (iron ore).
However, Price cautioned that not all emerging markets were the same, and that some compelling investment themes remained.
For example, while Russias economy is forecast to shrink by 3.6 per cent this year, Indias is expected to grow by 7.6 per cent, according to the median expectations of economists surveyed by Bloomberg.
Similarly, Ukraines dollar debt amounts to 80 per cent of GDP, Capital Economics estimates, while the figure for the Philippines is around ten per cent.
It is also worth remembering at times like this that emerging markets are home to 6bn out of the worlds 7bn people, Price added. And in many countries the internet, for example, remains nascent, while lower oil prices are greatly boosting the spending power of poorer householders in nations such as India.
Darby pinpointed Taiwan as more resilient to the EM gloom. The countrys most famous US customer is Apple, whose iPhone chips are made by Taiwan Semiconductor Manufacturing Corp, which has the largest weighting in the Taiex equity benchmark. TSMCs shares are trading near record lows, though the companys July sales were 25 per cent ahead of the same month last year.
The Taiex index, meanwhile, has hit a two-year low, valued at 12.1 times earnings, its cheapest valuation in nine years, and offering a 4.2 per cent dividend yield.
Investors seeking to pick an emerging markets fund may be challenged to find a manager who can outperform the overall asset class, as professional stock pickers remain relatively constrained by mandates that force them to stay close to a benchmark index.
Data provided by the New Zealand-based Copley Fund Research shows that Samsung, Tencent and TSMC the largest members of the MSCI Emerging Markets index by weighting are also the largest stock position held by 78 of 122 EM funds Copley has analysed.
This, according to the researchers, highlights the need for many funds to keep within a certain benchmark tolerance which in turn puts them at great risk of being slammed by generalised negative sentiment towards emerging markets.
