The start of the year has been bleak for investors. Domestic equity markets have had their worst start to the year ever and equity trading in China has been halted twice after markets in Shanghai cratered.
Should these first couple of trading days set a precedent for the year, emerging markets will be a principal driver of market performance for some time to come. HiddenLevers recently analyzed the emerging markets and this post will summarize the good, bad and ugly outcomes for the region and its effect on the global market equity market.
Commodities Rebound – The Good
Emerging market and BRICS countries are responsible for over half of all global economic growth, and most are commodities producers. A rebound in commodities prices would stoke a rebound in the energy and materials sectors as well as a fall in the US Dollar – benefitting the currencies of EM countries. Unfortunately, right now there is no plausible driver for this outcome and thus far markets have been moving in the opposite direction. A reversal of this trend would be benefit EM commodity producers - many of whom have a currency tied to the US Dollar.
EM Loses Footing – The bad
This seems like the most likely outcome and is already playing out in China. A rising US dollar can continue to push the price of commodities and foreign currencies down – adversely effecting emerging market countries.
The effects of falling commodities prices has already played out across commodity producing countries such as Brazil and Russia. However, we are starting to see the negative effects of weak EM currencies after China devalued its Yuan earlier in the month in a bid to stoke the economy.
Crippled by rate hikes – The Ugly
If rising interest rates in the US start to affect borrowing costs we could expect to see a major correction across the emerging markets. Emerging Market commodity and materials producers will have to cease operations as borrowing costs increase and commodity prices tumble further. As rates rise along with the value of the US dollar EM currencies will be near worthless or central banks will have tighten monetary policy – both actions will erode market returns in emerging markets and effect local economies.
Next Steps
With the Shanghai market crashing and Russia in a recession it looks like 2016 is going to be an interesting year for the emerging markets. It will be anyone’s guess if January’s trend continues and commodities move even lower or markets reverse and the emerging market indices begin to point upwards. Regardless of the outcome, advisors can utilize scenario based stress testing to help identify and protect against market volatility.
