The second quarter of this year was even more challenging, with the index dropping 7.86%. Not surprisingly, asset managers have responded with commentaries on the decline. While each firm has their own spin on the matter, a historical perspective of emerging markets can help keep recent volatility in perspective.
Indeed, for advisors and advisors’ clients, the recent market decline shouldn’t be a surprise. The volatility, furthermore, underscores the need for advisors to prepare their clients for challenging market conditions.
A handful of developments has driven volatility in emerging markets this year. As the year has progressed, the Federal Reserve has signaled its increased commitment to raising the Fed funds rate, which has resulted in a two-pronged assault on emerging markets.
First, monetary policy has resulted in a stronger U.S. dollar. The end result is that emerging market returns, when calculated in U.S. dollars, has declined. Secondly, higher interest rates have been fueling fears that financing costs for corporations, including those in emerging market countries, may increase, thereby creating a headwind for economic growth.
Some emerging market countries, furthermore, have outstanding debt that is denominated in U.S. dollars. In such instances, a strong U.S. dollar can increase debt payments.
Rising oil prices are also being viewed as a threat to emerging market countries, or at least those countries that don’t export energy commodities.
Finally, President Donald Trump’s protectionist measures, including slapping tariffs on goods imported from Canada, Mexico, China, and Europe have also weighed upon sentiment for emerging markets by sparking fears of a potential global trade war that can be a drag on worldwide economic growth.
Morgan Stanley has reacted by calling for an emerging markets bear market, reports The Business Times.
Jonathan Garner, Morgan Stanley's chief Asia and emerging markets strategist, says rising oil prices have been a drag on 80% of emerging market economies this year. He is also concerned that stocks of automobile manufactures could tumble and he has observed that earnings estimates for companies that provide technology hardware, such as semiconductors and mobile phones, have been declining.
Mark Mobius, who is a well-known emerging markets investor and the co-founder of Mobius Capital Partners, maintains that the recent concerns about global trade and other economic headwinds have made this an ideal time to invest in developing countries, reports CNBC.
Those concerns have resulted in emerging market equity valuations becoming extremely attractive. He also maintains that an escalating trade war between the U.S. and China could result in Vietnam, Bangladesh, and Turkey increasing their exports to America, so certain companies in those countries have potential for increasing their sales.
State Street Global Advisors has also weighed in on emerging markets, but has taken a balanced viewed. On one hand, the portion of emerging markets debt denominated in U.S. dollars has decreased over the years, so developing countries may be less susceptible to a strengthening dollar.
Yet, earnings growth relative to developed markets are expected to moderate. Based on consensus estimates, emerging markets earnings should climb 15.9% this year compared to 15% for developed markets. In comparison, earnings growth in emerging markets exceeded developed markets by 500-600 basis points last year. Global trade volume has also weakening.
For advisors, the recent emerging markets decline underscores the need to educate clients on risk. From an historical perspective, the recent decline isn’t exceptional. From the start of March in 2015 through January of 2016, emerging markets generated a series of monthly declines with the exception of November.
May and June were the most dramatic with declines of 6.87% and 9.01%, respectively. In January of 2016, emerging markets declined 6.48%. By describing such declines with clients, advisors can reduce the likelihood of clients panicking when emerging markets decline.