Investors are dumping emerging market stocks as they brace for trade tariffs proposed by President-elect Donald Trump and contend with a surge in the dollar and rising bond yields.
MSCI's emerging markets index, which tracks nearly $7.6 trillion in stocks in China, India, Brazil, South Africa and other markets, has fallen more than 10% since hitting a two-and-a-half-year high on Oct. 2. During this period, market inventories were roughly flat.
Emerging markets have been hit by bets that inflationary policies such as tariffs and tax cuts under Trump, building on an already buoyant economy, will force the Fed to keep interest rates higher for longer than previously expected. U.S. government bond yields have moved sharply higher in recent weeks as traders reassess the outlook for inflation.
"That's clear as U.S. Treasury yields rise and the U.S. dollar strengthens. . . . This is definitely not the environment for emerging market performance," said Emre Akcakmak, a portfolio adviser at emerging markets fund manager East Capital. "Major markets, which make up two-thirds of the (MSCI) index, are under pressure," he added.
Chinese stocks, which make up the largest share of the index, have fallen 15% since Oct. 2 amid concerns about the health of the country's economy. Two other emerging market heavyweights, India and South Korea, have also suffered significant losses in recent months.
Investors have withdrawn about $3 billion from global emerging market equity funds so far this year, according to JPMorgan Chase & Co., after outflows of $31 billion last year.
A longer period of higher U.S. interest rates and a stronger dollar typically entice U.S. investors to stay at home rather than make more risky investments overseas.
Investors are now betting that countries will try to weaken their currencies and make exports more competitive in response to U.S. tariffs, a move that will depress dollar gains in emerging markets.
"There's a general consensus that protectionism is getting worse and that America First is the only way forward," said Archie Hart, emerging markets equity portfolio manager at Ninety One. However, he added that markets had priced in that for years. Turbulent trade relations.
Some investors were prepared to sell off emerging market assets in the first half of the year and then rebound, betting that tariffs would initially be set higher than Wall Street consensus but lowered as Trump struck deals with individual countries.
Kristina Hooper, chief global market strategist at Invesco, said: "Right now, what we're seeing is a very emotional, irrational reaction, so that historically creates a buying opportunity. ”
However, other investors remain reluctant to return to emerging markets because it means there is a lot of potential risk in Chinese stocks that, unless they exclude them from their indexes, could obscure moves in other countries.
These concerns were highlighted last week when the social media and gaming giant Tencent's shares fell sharply after the Pentagon identified the company as having alleged ties to China's military. The company makes up about 4% of the MSCI index, equivalent to the benchmark index's overall weighting of Brazilian stocks.
"For a lot of people, China has just become a bit of a pariah; said Mark McCormick, head of FX and emerging markets strategy at TD Securities.