Jittery Emerging Markets, Interest Rates and the Blame Game

September
08

Written by: Jon McGraw

So, who’s the culprit?

Speculating on who or what is to blame for recent market weakness is a popular pastime right now. Last week, Barron’s said the search for someone to blame is a lot like a game of Clue. So far, the most common conclusions are “the People’s Bank of China with a devalued currency in Beijing” and “Janet Yellen with a potential interest-rate hike in Washington.”

The article pointed out those theories might be flawed. After all, China’s slowdown wasn’t a surprise. Analysts have been factoring slower growth into their calculations for some time. Hikes in U.S. interest rates are highly anticipated, and even though some fear they could tip the American economy into recession (and argue recent stock price movement supports the claim), relatively strong economic data casts doubt on the idea. Some analysts believe the stock market can help predict where a country’s economy is headed. A significant drop in stock prices could be indicative of a future global recession, and a significant increase could suggest future economic growth.

So, why have stock markets headed south? Barron’s offered an alternative answer: investors with volatility trading strategies (and/or a case of nerves) across the globe. The article pointed out the CBOE Volatility Index (VIX), aka the fear gauge, popped from a low of 13 to a high of 53 between August 18 and August 24:

“That’s higher than when Standard & Poor’s cut the credit rating of the United States in 2011, or at the peak of the European debt financial crisis in 2010, and seems extreme given the evidence. But volatility isn’t simply a measure of fear. It has been used to manage risk in portfolios that employ sophisticated trading schemes … Although each type of fund adjusts to market changes at a different speed, they all respond in the same way—by selling stocks … Don’t just blame the professionals. For months now, there have been warnings about overcrowding in the market’s best-performing stocks. And, when the market started to tumble in August, these stocks were among the hardest hit …”

So, who caused the market downturn? Take your pick.

Data as of 9/4/15 1-Week Y-T-D 1-Year 3-Year 5-Year 10-Year
Standard & Poor’s 500 (Domestic Stocks) -3.4% -6.7% -3.8% 11.0% 12.0% 4.5%
Dow Jones Global ex-U.S. -4.1 -8.8 -17.0 2.3 1.0 1.0
10-year Treasury Note (Yield Only) 2.1 NA 2.5 1.6 2.6 4.1
Gold (per ounce) -1.5 -6.8 -12.1 -13.0 -2.2 9.6
Bloomberg Commodity Index -1.0 -15.2 -29.0 -15.5 -8.2 -6.4
DJ Equity All REIT Total Return Index -4.6 -9.0 -3.0 6.5 10.6 6.0

The Travails of Emerging Markets

Just a few years ago, emerging markets were the toast of the town. In general, emerging countries recovered much faster than developed countries following the financial crisis and global recession. The MSCI Emerging Markets Index delivered pretty remarkable (and highly volatile) performance during the past decade. According to the MSCI fact sheet, annual returns have ranged from down 53.33 to up 78.51:

Annual Returns (%)

2005 34.00
2006 32.14
2007 39.42
2008 -53.33
2009 78.51
2010 18.88
2011 -18.42
2012 18.22
2013 -2.60
2014 -2.19

 

Through September 4, the Emerging Markets Index was down 17.54 percent. While that’s a significantly smaller swing than some we’ve experienced during the past 10 years, any double-digit dip demands attention. The Wall Street Journal explained the downturn like this:

“China’s economic slowdown is having broad implications, hitting regional economies like Taiwan, Malaysia, and Vietnam where manufacturing data showed declines for August. Emerging markets are also nervous about the possibility of an interest-rate increase in the United States, which would encourage global investors to invest more there. China’s Shanghai Composite Index is down 39 percent after hitting a seven-year high in June.”

Indeed, money is moving back into the United States. Experts cited by The Economist said about $44 billion has been pulled from emerging markets since mid-July.

Christine Lagarde, Managing Director of the International Monetary Fund, indicated the IMF’s outlook for global growth was likely to be revised downward, in part, because emerging economies are at risk of being negatively affected by commodity price weakness, China’s slowdown and America’s monetary policy.

How bad will it get in emerging markets? The IMF’s July projection was that emerging-market and developing countries would grow by 4.2 percent in 2015 and 4.7 percent in 2016. Developed economies, on the other hand, were expected to grow by 2.1 percent in 2015 and 2.4 percent in 2016.

Please keep in mind, international investing involves special risks such as currency fluctuation and political instability and may not be suitable for all investors. These risks are often heightened for investments in emerging markets.

Weekly Fun—Think About It

“I never blame myself when I’m not hitting. I just blame the bat and if it keeps up, I change bats. After all, if I know it isn’t my fault that I’m not hitting, how can I get mad at myself?”

Yogi Berra, baseball player