Historically, a steep sell-off or market crisis on Wall Street has spread overseas with alarming velocity, including the volatile emerging markets. But that’s not the case this year with the majority of emerging market stocks and bonds sharply recovering from their post-July lows; in fact, benchmark indices have virtually recovered from their steep August correction and now stand just a few points off their all-time highs.
Compared to emerging markets, the major markets or industrialized economies have tanked since hitting highs in June and July. That’s especially the case with smaller company stocks in the mature economies, hammered since peaking two months ago. Larger company shares have also declined but have mostly rebounded since dropping 10% from their highs last month.
The Dow is still 5% off its high while the MSCI World Index stands 4.5% off its best level. But the MSCI Emerging Markets Index is only 3.5% off its all-time high – a surprising statistic in the wake of the worst global credit crisis since 1998.
Although credit spreads for emerging market bonds remain historically low compared to Treasury bonds, the gap did not widen all that much since credits began imploding in mid-July. From its all-time low, emerging market fixed-income credit spreads rallied from 188 basis points to just under 300 basis points almost three weeks ago. That’s hardly a serious risk aversion reaction. But junk bond or high-yield spreads have widened much more over the same period and currently sit at 376 basis points over T-bond yields. This tells me that global investors, despite the panic in world markets over the last eight weeks, have more confidence in emerging markets paper than high-yield and mortgage-backed securities.
But it’s not all clear sailing for some emerging markets.
Several countries, namely in the Baltics, Balkans and Eastern Europe continue to flirt with dangerously overvalued currencies and bulging trade deficits. The worst offenders include Latvia, Hungary, Turkey, Bulgaria and Romania. In many ways, these markets and regions currently exhibit the same macroeconomic imbalances that preceded the 1997-98 Asian economic crisis.
The safest emerging markets remain those with massive trade surpluses, booming foreign-exchange reserves and exports tied to commodities. Russia and Brazil are leaders in this respect and deserve top marks for prized economic and fiscal achievements over the last five years.
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