It seems that all anybody thought about over the long holiday weekend was the slide in the emerging markets. On a number of fronts the anxiety over the emerging markets slide is rising, something we noted over a month ago. We think the rise, and subsequent fall in the emerging markets, is a function of three major factors.
- The fundamentals underlying the economies and capital markets in the emerging markets have been quite favorable. This is due in part to the supporting effect of rising commodity prices. By and large the emerging markets are on a sounder footing than any time in recent memory.
- The mantra of international diversification, including the emerging markets, which has been preached by academics and financial professionals for some time finally took hold with the investing public.
- Good old fashioned momentum investors, including hedge funds have exacerbated and accelerated these "rational" moves to a great extent.
We have made a similar argument in regards to the commodities markets as well where a bull market in spot commodities coincided with a reallocation of capital into the commodities futures market.
A review of recent commentary shows a decided increase in the anxiety of investors, many of whom have large unrealized profits in their emerging market investments. While some call for a fall in the emerging markets, others preach patience driven in large part by the fundamental success of these markets. A sampling of commentary follows.
Both the Wall Street Journal and the Financial Times highlight the conclusions of a World Bank report that is cautious about the effects of massive capital inflows into the emerging markets. The fear is that the reversal of these flows could induce a cash crunch which repeats the crisis of the late 1990s. Another less reported fact is the concentration of capital in a handful of internationally known companies which could increase the risk of a crisis.
Brett Steenbarger at TraderFeed has accumulated a basketful of observations which demonstrate the simultaneous signs of anxiety amongst the emerging markets. He wonders about the effects of a "perfect storm" where investors seek the exits simultaneously.
E.S. Browning in the Wall Street Journal examines the role rising global liquidity has played in lifting all markets simultaneously thereby increasing correlations among the markets. The fear is that tightening credit will disproportionately harm those markets, like the emerging markets, that have benefited the most from loose credit.
Gregg Wolper at Morningstar.com thinks investors should use this occasion to re-examine their exposure to the emerging markets in light of this slide. The question for investors to ask is why they purchased emerging markets exposure in the first place?
Tim Middleton at MSN Money is far more fearful and believes the emerging markets party is over given historical trends.
On the cautionary side is the story of William F. Browder, a large and early investor in Russia who has subsequently been banned from returning to the country. Frederick Kempe in the Wall Street Journal profiles the contradictions inherent in investing in a market free of shareholder protection.
For better or worse the prospects of the emerging markets is now dependent on how the "hot money" deals with this most recent decline. Despite this flood of opinion we do not know how emerging market investments will fare in the future. For an investor with a regular re-balancing program the large return on their emerging market investments would at some point have indicated some movement away from the emerging markets.