Emerging Markets Investment Case Weakening in August

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Emerging Markets Face August Setbacks

The appeal of bonds and stocks from emerging markets is fading in August, with both asset classes positioned for their most significant monthly declines since September of the previous year. A series of events, including Nigeria’s central bank revealing lower reserves than anticipated, a political outsider winning primaries in Argentina, and the assassination of a presidential candidate in Ecuador, have collectively contributed to the current upheaval.

High Returns, High Jinks: Navigating Emerging Markets

The current tumultuous environment, coupled with a surge in US Treasury yields and underwhelming economic data from China, has prompted investors to reconsider their stance on riskier assets. This evolving situation underscores the fact that high returns often come with heightened levels of uncertainty.

Carlos Legaspy, CEO of Insight Securities, underscores that the risks associated with emerging markets have always leaned more toward the political sphere than the economic one. The ever-shifting landscape of these markets highlights their inherent unpredictability.

Shakeup in Emerging Markets Investment Narrative

Within a relatively short span, the narrative for investing in emerging assets has undergone a considerable shakeup. Government bonds denominated in dollars have pared down their 2023 gains from a peak of 5.8% to about 2.5%. Moreover, the MSCI Inc. currency index has eroded much of the year’s initial rally. Stocks are also on track for their worst August performance since 2015, contributing to the recalibration of global capital markets.

Unveiling the Fragility of Emerging-Markets Rallies

The recent setbacks serve as a stark reminder of the fragility of emerging markets’ rallies. These rallies can swiftly unravel due to heightened volatility, which elevates the risk profile and could potentially trigger further selling. The Cboe Emerging Markets ETF Volatility Index is on the rise for the second consecutive month in August.

Mitigating Risks: Market-Friendly Reforms

Mila Skulkina, a portfolio manager at Lord Abbett & Co., suggests that focusing on investing in countries that are embracing market-friendly reforms can help mitigate risks, especially in regions like Latin America and the Middle East. She points out that the emerging markets investment landscape of today differs significantly from two decades ago, with many crucial emerging-market nations implementing reforms to navigate challenging times.

Unsettled Outlook in Certain Regions

However, the outlook remains uncertain in certain regions, particularly in Argentina and Ecuador. Both countries, historically prone to defaults, are currently experiencing presidential elections, which has led to increased uncertainty for investors.

In Argentina, overseas bonds have plummeted as Javier Milei unexpectedly surged in a closely watched presidential primary vote. Milei’s pledges to abolish the central bank and dollarize the economy have created uncertainty for market-friendly reforms.

In contrast, in Turkey, where President Recep Erdogan has appointed an advocate of conventional policies, there’s an inclination towards shifting away from measures associated with inflation and foreign capital outflows.

Ecuador is also grappling with uncertainty due to a recent candidate’s assassination, just ahead of snap general elections. Although the nation’s dollar-denominated debt experienced an uneasy rally post-tragedy, some anticipate that the next leader will address issues such as rising crime rates and economic instability.

Navigating Emerging Markets: A Complex Endeavor

Investors in different regions are grappling with recent developments. In Nigeria, the naira’s crucial support eroded as the central bank’s financial statements disclosed lower effective foreign-exchange reserves than initially reported. Russia’s unexpected reintroduction of capital controls and a significant increase in interest rates have also caught analysts off guard.

While emerging markets have shown promise, recent events underscore the challenges and uncertainties inherent in investing in these markets. The complex interplay between politics and economics makes navigating these waters a demanding endeavor for investors seeking growth opportunities.

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