June 26, 2013
Emerging market stock and bond funds have returned to their roots — destroying massive sums of investors' money, despite the popular belief that they've been transformed into mild-mannered investments over the past few years.
Made up of stocks and bonds from areas from China and Vietnam to Brazil and Peru, many have plunged 20 percent or more. That's a much worse performance than U.S. stocks and bonds during the downturn that began in early May. The violent declines in emerging market investments are reminiscent of those inflicted on Asian and Latin American stocks, bonds and currencies in the past.
Investors may be surprised by the extreme losses delivered since early May because the popular story that investment pros have been telling clients during the past few years has been that emerging markets had mellowed. In fact, the line repeated in many a meeting with investment clients has been that emerging markets could actually turn out to be more dependable than the U.S. because many emerging economies were growing more and governments were watching their national debt.
Then along came rising interest rates in the U.S. over the past couple of months, and speculators bolted from emerging markets the way they have time and time again. The thinking: If rates on Treasury bonds are headed higher, why take a chance on more speculative areas of the world when the U.S. will pay decent interest with less risk? Throw into the thinking the fact that emerging markets aren't really growing as much as investors had expected, and you give speculators reason to bolt immediately and ask questions later.
This week, concerns about emerging markets were sparked further when China, the second-largest economy and major customer for emerging market commodities, revealed major problems of its own. The country's growth has slowed considerably, perhaps far more than the 7.4 percent anticipated by analysts who depend on questionable Chinese government data. In addition, the Chinese government has been concerned about a speculative real estate bubble and has been attempting to deal with dangerous lending practices. Yet as the government tried to stop some of those practices this week, analysts worried that borrowers who need money won't be able to get it.
In other words, the concern is a credit crunch, capable of strangling growth in China. Investors recall that a credit crunch in the U.S. was at the heart of the financial crisis here.
"The challenge for the (Chinese) authorities is to warn of potential liquidity risks but not to trigger a sharp economic slowdown or a financial sector crisis," said Citigroup Asia economist Minggao Shen in a recent report. "The weak economy in combination with skyrocketing money market rates potentially could take the Chinese economy into a crisis."
The government calmed investors Tuesday by reporting it had the situation under control. But China's Shanghai index remains down 15 percent for the past month and almost 20 percent since early February. As China's economy has slowed, it has taken with it emerging markets, such as Brazil and Chile, that have depended on China to buy raw materials for its construction boom. In addition, countries such as South Korea and Taiwan have depended on China to buy products such as information technology.
Brazilian stocks have declined about 22 percent in a month and Chile's are off about 14 percent, while the iShares MSCI Emerging Markets Index Fund, which involves a wide range of emerging markets, has declined 13 percent.
And it's not merely stocks that have plunged. Investors, frustrated with interest rates below 2 percent on U.S. Treasury bonds, have been taking increasing chances on emerging market bonds. But with yields on Treasurys climbing over 2.5 percent, investors see investment opportunities differently and have dumped emerging market bonds. The iShares JPM Emerging Bond Fund has lost about 11.6 percent in a month.
Issues dragging down emerging market investments range from elevated inflation, souring business sentiments and infrastructure bottlenecks in Brazil to economic malaise in India and sluggish growth in Russia, said J.P. Morgan economist Bruce Kasman in a recent report.
Since emerging markets have been battered lately, some analysts are suggesting investors prepare to buy the stocks. Yet, Richard Bernstein, of Richard Bernstein Advisors in New York, sees no reason to do so. He says investors have misunderstood emerging markets.
They've been driven, he said, by a tremendous boom in credit that made it possible to grow at a fast clip from 1998 to 2008. But now there is "a sea change," with the trend involving "a decline in global credit."
That means, he said, that investors will be disappointed if they count on emerging markets, commodities and gold to become the large gainers that they were amid the credit boom.
Instead of emerging markets, he is recommending that investors stick with solid U.S. companies that depend on domestic business rather than multinationals trying to sell into emerging markets. Among his picks are small U.S. banks.
Meanwhile, Sean Lynch, strategist for Wells Fargo Private Bank, says risks continue in emerging markets in the short run, but he wants clients to stay invested in them because he sees growth during the next decade.
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