It has been a hard start to the year, especially for emerging markets, but the latest dislocation is a healthy part of the cycle and the risk-on trade remains intact.
The current rout in emerging markets is a healthy turn in the economic cycle. My optimism stems from the fact that when we see weakness, such as this in emerging markets, it can actually have a positive knock-on effect for the global economy.
Pressure on emerging market currencies is disproportionately affecting resource-centric countries such as Brazil, Chile and Russia. As those exchange rates fall, richer nations such as the United States, euro zone countries, Britain, and Japan will enjoy cheaper import prices. China should also benefit from cheaper prices of the natural resources it imports.
In addition, as U.S. Treasuries rally, it brings down mortgage rates in the United States, leading to a pick-up in U.S. housing activity. A robust U.S. housing sector sparks consumer spending and spurs faster overall economic growth in America, which is positive for all economies.
The situation in emerging markets today seems unlikely to derail the global economic expansion. The current market dislocation has more in common with the 1994 Mexican economic crisis, which remained localized, than the 1998 Asian crisis, which threatened to derail the global economic expansion and required myriad bailouts. Despite a rough January, the risk-on environment is intact.
For investors seeking emerging market exposure, the latest swoon is welcome news. Countries such as Malaysia, Indonesia and the Philippines, where valuations last year were expensive based on stock market capitalization to GDP, now present better value.
Sell-Off in EM Currencies Offers Entry Point
After the Fed in December announced plans to taper its asset purchases, currencies in emerging market economies (EM) with large current account deficits have continued to depreciate against the U.S. dollar, with an average depreciation of 2.8 percent. However, as market stress intensifies, investors have become less discriminating on EM assets. Currency values in countries with a current account surplus, which held up relatively well during market turbulence last summer, have declined 4.0 percent since the Fed meeting in December 2013. The bearish sentiment across EM, particularly in countries with strong economic fundamentals, could provide investors with an entry point for compelling returns in the medium-to-longer term.
NORMALIZED WEIGHTED AVERAGE FOREIGN EXCHANGE RATES PER U.S. DOLLAR IN MAJOR EMERGING MARKETS*
Source: Bloomberg, Haver, Guggenheim Investments. Data as of 1/29/2014. *Note: Exchange rates are local currency per U.S. dollar, and are normalized to 100 at the end of 2012. Major EMs with a current account surplus include Hungary, South Korea, Malaysia, Russia, Singapore, Philippines, and Nigeria. Major EMs with current account deficits include Chile, Colombia, India, Indonesia, Thailand, Brazil, Poland, Mexico, South Africa, Turkey, Ukraine, and Peru. Data is weighted by comparable GDP and we exclude EMs with controlled exchange rates such as China and Argentina.
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