Following the Fed's surprise move on Wednesday to stick with the current pace of its $85 billion a month quantitative easing policy, global markets correctly discerned that roughed-up emerging-country stocks had won a reprieve. And the most hard-hit emerging markets, specifically India, appear poised to benefit most from the relief rebound.
Ben Bernanke is not central banker to the world. He has, in fact, disclaimed any direct consideration of emerging markets' financial conditions in his policy decisions at the Federal Reserve. Yet the way markets in Jakarta, Mumbai and Sao Paolo have reacted to his word and deed, he and his colleagues might as well have been acting on the developing world’s behalf on Wednesday.
As global investors and their perspicacious trading machines absorbed the news of a quantitative easing status quo, nearly every asset price surged aside from the dollar, which dove hard. Stocks, gold, oil and bond prices all popped higher. And emerging-market stocks, hammered for months after Fed officials began hinting of a possible reduction in QE by year’s end, led the way in equities.
An emerging markets recovery story was already playing out a bit in September before the Fed announcement, with the iShares MSCI Emerging Markets (EEM) up around 8% amid bets on global growth. And from the instant the Fed’s “non-taper” news hit at 2 p.m. until the market closed that day, it jumped 4.1%, compared to 1.3% for the domestic Standard & Poor’s 500 index. (It has since given back some of those gains, along with the broader market, down around 1.8% on Friday.)
Capital that had rushed into these countries to collect higher yields exited in anticipation of a less-generous Fed, depressing their currencies and stock markets and exacerbating serious domestic-inflation pressures – which their central banks struggled to fight through higher interest rates that slowed their already-sluggish economies.
Emerging-market stocks underperformed the S&P 500 from Dec. 31 through August by a whopping 30 percentage points. This drove massive investor outflows from emerging-markets stock funds – totaling $51 billion from March into September, says Michael Hartnett, global strategist at Bank of America Merrill Lynch. These withdrawals have abated for now, and Hartnett offers that what he calls a “bear market rally” that began in summer is “not over yet.”
Other market watchers think the rally could be more than a mere strong bounce. Societe Generale strategist Benoit Anne predicted at least a multi-week pop that represents the end of EM bears’ domination. “Global emerging markets are settling in a new regime,” he says. “That new regime is no longer a bear market, in our view."
Within emerging markets, India represents an intriguing potential opportunity for investors tuned into this next chapter of the EM story. For one thing, India’s market was among the most damaged in the EM rout. Coming into this week, Indian equities ranked 50th of the 58 global stock and bond markets tracked by BofA Merrill, and in the prior three months were 53rd. (Only Turkey and Indonesia assets fared worse.)
The largest exchange-traded funds that track India, including iShares India Nifty 50 Index fund (INDY), remain down double-digit percentages this year, even after bouncing strongly in September. Beneath the top tier of global India-based companies, smaller domestic stocks have been ravaged, with the Market Vectors India Small-Cap ETF (SCIF) down more than 40% year to date.
Then there’s the fact that India is looking like a test case for the idea that the Fed’s unabating liquidity-adding pace in a sense gives cover for local central bankers to firm up their currencies and slow consumer inflation. Overnight, the Reserve Bank of India’s new Governor Raghuram Rajan surprised markets by raising its key lending rate by a quarter-point – a bold move that sent a clear inflation-fighting message. This is a crucial issue in the country, where, for example, onion prices have climbed more than 200% in the past year.
India stocks gave back more than 1.5% of their recent gains, but this is a relatively modest dip, and the Indian rupee got a lift on the rate news. Higher official interest rates will surely complicate the outlook for reviving Indian economic growth. But with asset prices already so bruised, investors should arguably embrace a tough-love central-bank stance.
Rahul Saraogi of India-focused fund Atyant Capital, noted in a presentation this week at the Value Investors Congress that small and mid-sized Indian companies are trading at 10-to-12-year valuation lows and Indian investors spent the past few years pulling money from mutual funds to chase after gold before the metal peaked. Both imply the market is near a washed-out state.
While the details and key catalysts are different, this sort of depressed investor sentiment backdrop resembles the one that prevailed in South Korean stocks a few months ago, when the bullish case for the now-resurgent iShares MSCI South Korea Capped ETF (EWY) was made here.
One distinguishing feature of India versus other big EM countries is it is not a proxy for commodities or global industrial demand. Basic materials stocks make up only 8% of the benchmark India index. An investment in India is a bet on internal domestic consumer growth and technology development – in a democracy of 1.2 billion, half of them under age 30, with strong rule of law and transparent (if messy) policy making.
For patient investors, this might appear a pretty good bet indeed, and the emerging-markets washout has made for a decent entry point in India for a long-term play, rather than a mere trade based on Bernanke’s latest, or next, move.
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