Emerging-market (EM) stocks fell in the third quarter and continued to diverge sharply from developed-market equities. While it may be too soon to buy into the weakness, investors should watch for signs that could herald a quick rebound.
US, European and Japanese stocks have all advanced this year.
But the MSCI Emerging Markets Index has tumbled in local-currency terms—and even more in US-dollar terms. EM returns have been dragged down by Turkey’s currency crisis and concerns that China’s challenges could be aggravated by the escalating trade war with the US. Investors are asking whether the sharp pullback since January will continue and are watching for signs of contagion to other markets.
After a two-year EM recovery, investors are fearful that a systemic crisis is imminent. We think it’s important to separate the issues and put the risks into perspective before withdrawing investments from EM stocks or allocating more to EM stocks in anticipation of a recovery.
Individual country performance provides a reminder that emerging markets aren’t all made of the same stuff. Turkish and Argentinian stocks were the worst EM performers this year, while markets in China and South Korea have also fallen. Russian and Thai stocks posted gains. In many markets, sharp declines in local-currency values led to much steeper losses in US-dollar terms.
Two Problems, Two Risks
There are two types of problems on the EM landscape today. First, there are countries mired in major economic and currency crises. Second, there is China.
Turkey, South Africa and Argentina are members of the first group. These countries are dealing with classic EM crises: poor policy decisions, wide current account deficits, excessive foreign-denominated debt and collapsing currencies. There’s no way to sugarcoat it: each country— and its people—faces an arduous road to rehabilitation.
After large inflows to EM stocks and bonds from 2016 through early 2018, a panicked withdrawal by investors could spread elsewhere. The strong dollar and rising developed-market interest rates could create contagion beyond the developing world, for example, spreading to European banks with large Turkish assets. And investor sentiment could also hurt returns even if fundamentals outside these countries are relatively sound. That said, these countries have relatively small economies, and their weights in the benchmark are also limited. So, we believe that their troubles are likely to remain ring-fenced and their ailments probably won’t infect the rest of the world.
The Challenge For China: The Right Policy For A Trade War
China is a different story. What happens to the world’s second-largest economy matters profoundly to the rest of the world, and the issues it faces are unprecedented. Here, the challenge for policymakers is to carefully manage slowing growth and a shifting economy while strategically navigating a trade war with the US.
Pressure is mounting on China’s policymakers. On September 23, the US imposed tariffs on a further $200 billion of Chinese goods. China retaliated with tariffs of $60 billion on US goods, but its broader response has been relatively restrained. We think China has three options to stimulate growth if the trade war begins to weigh on its slowing economy.
About Sharon Fay
Sharon E. Fay is Head and Chief Investment Officer of Equities and a Partner of Alliance Bernstein (AB). She is responsible for overseeing the firm’s portfolio management and research activities relating to all equity investment portfolios. Prior to this Fay served as CIO of Global Value Equities from 2003 to 2014. From 1999 to 2006, she was CIO of European and UK Value Equities, serving as co-CIO from 2003 to 2006 after being named CIO of Global Value Equities in 2003. From 1997 to 1999, Fay was CIO of Canadian Value Equities. Fay holds a BA from Brown University and an MBA from Harvard Business School and is CFA charterholder.