The emerging markets bear trap (Part 1 of 4)
What got emerging markets to where they are
A lot has changed over the past nine months. The first quarter of the year was off to a strong start, with both emerging markets and the US economy moving higher as investors gained confidence that recovery was on its way.
This short series aims at giving a very rough overview of the emerging markets landscape. In other articles, we go into deeper detail. So this series is an eagle’s-eye view that gives investors a great place to start.
Quick catch-up on what happened earlier this year
By mid-June, the picture had completely changed, as Bernanke had spooked the markets with premature talks about tapering. The initial hints at a slowdown of money printing started to push interest rates higher, raising the cost of funds and throwing a wrench into the investment inflows in emerging markets.
Aside from the reduced inflows due to the higher cost of funds, emerging markets were hit hard by currency depreciation as expectations of a stronger dollar boosted the US dollar versus the local currencies. The weaker currencies reduced the purchasing power, which lowered imports by emerging markets, putting a dent into the so-called “South-South” trade (trade among emerging markets). This also raised costs for many producers, whose inputs were usually US dollar–denominated, such as commodities. Higher costs meant tighter margins and lower ability to price competitively.
Many investors are still holding on to their emerging market exposure. While I’m not advising against this, I’m trying to explain why there’s limited upside in the near term and why emerging markets should be selectively (that is, country-by-country) included in a portfolio.
Browse this series on Market Realist: