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Navigating EM turbulence

20-Aug-2018
By Richard Turnill

Key points

  1. Turkey’s woes have hit emerging markets. We expect further volatility, yet see long-term opportunities in markets with strong fundamentals.
  2. EM equities lagged broader global markets, dragged in part by weak Chinese tech stocks. Copper prices hit a one-year low.
  3. Minutes from the Federal Open Market Committee could signal an earlier end to the Federal Reserve’s balance-sheet drawdown than expected.

Navigating EM turbulence

Worsening relations with the US have spurred a sharp selloff in Turkish assets and exposed economic weaknesses such as large external debt loads and rampant inflation. We see many of these problems as unique to Turkey, yet other emerging markets (EMs) have felt the heat. We remain wary of markets with high debt and deteriorating growth, and prefer regions with sound fundamentals, such as EM Asia.

Chart of the week

Past performance is not a reliable indicator of current or future results. It is not possible to invest directly in an index.

Rising macro uncertainty, higher interest rates and a strengthening US dollar have led to a modest tightening of global financial conditions. This has laid bare vulnerabilities that had, until recently, been masked by plentiful global liquidity. Countries reliant on external borrowing to fund growth and large current account deficits — such as Turkey and Argentina — have suffered the most, as the chart above shows. Currencies of both have lost more than 40% against the US dollar this year to date. Yet both Turkey and Argentina are relative outliers within the EM world. Many other EM countries, especially in Asia, appear healthier with improving current account balances. And structural reforms in countries such as China and India are likely to put economies on the path to more sustainable, long-term growth, in our view. See our emerging market marker to compare EMs across key metrics

Look east

Investors have latched onto Turkey’ s weak fundamentals — bubbling under the surface for years — and rushed for the exits after the country‘s relations with the US took a sharp turn for the worse. Turkey’s woes have brought into sharp focus the dangers of a reliance on external debt-fueled growth. We believe the weakness could persist, as markets are skeptical that Turkey will take the necessary steps to address these underlying issues.

The dent to broad EM sentiment is undeniable. Currencies, especially of countries dependent on borrowing in dollars, have sold off. Outflows from equity and debt funds have resumed, according to EPFR. Poor equities and debt performance in 2018 after two strong years has dampened investor appetite. Some safe-haven assets now offer positive real returns and investors see brighter prospects in markets such as the US If the latest proposed US sanctions come down hard on Russia, this could further dent sentiment on EMs.

Yet the risks of economic or financial contagion to other regions are low, we believe, as several of Turkey’s challenges are unique. Geographical proximity has raised concerns about the impact on Europe. Turkey represents about 3% of eurozone exports, equivalent to less than 1% of eurozone GDP, according to the IMF. Turkish loans make up only a small proportion of eurozone bank lending. Turkish stocks constitute less than 1% of the MSCI EM equity index. And we believe strong earnings growth and attractive valuations overall in EM equities compensate for the risks. Strong growth in developed markets still supports EM economies.

The prospect of a bumpier road ahead for markets raises the importance of portfolio resilience, a key theme of our midyear Global Investment Outlook. We recommend sticking with markets with strong fundamentals and companies with strong balance sheets. China’s growth is poised to benefit from policy support in the near term. China and India are two of our top EM Asia equity picks. We are neutral on EM debt, with a preference for selected hard- over local-currency debt.

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  • EM equities lagged broader markets, hit by a combination of trade fears, worries about spillovers from Turkey and weakness in Chinese tech stocks. Copper hit its lowest level in a year as industrial metals suffered on the back of broad EM weakness and a stronger dollar. The S&P 500 recouped earlier losses to advance back near record highs.
  • Chinese economic data underwhelmed. Fixed-asset investment growth and industrial output undershot expectations. The yuan weakened slightly against the US dollar. News of China and US resuming trade talks brightened sentiment.
  • Italian bond yields jumped to four-year highs on growing investor concerns that the country’s budget submission to the European Commission in October could lead to a showdown over fiscal responsibility.

 


 

  Date: Event
Aug 20 US public hearings begin on imposing 25% tariffs on $200 billion of Chinese imports
Aug 22 Eurozone flash PMI, Japan CPI, central bankers’ conference in Jackson Hole kicks off
Aug 23 US Federal Open Market Committee (FOMC) minutes

Next week's August FOMC meeting minutes will be watched for hints on whether the Fed has started discussions on ending its balance sheet drawdown sooner – and at a higher level than estimated. The Fed is taking a closer look at the technical implementation of monetary policy – how it sets short-term rates – as overall bank reserves decline with its balance sheet. The FOMC minutes could indicate some members see a need to maintain the current “floor system” for controlling the fed funds rate and may need a higher level of bank reserves to do so. This would imply an earlier end to the Fed’s balance sheet normalisation than many in the market expect.

Richard Turnill
Managing Director, ist Global Chief Investment Strategist von BlackRock
Richard Turnill ist Global Chief Investment Strategist von BlackRock. Davor war er Chief Investment Strategist von BlackRocks Fixed Income und active Equities ...

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