Investors remain wary after market storm

05/06/2006 | Duncan Hooper

Fund managers unwilling to commit to emerging markets in the wake of recent market volatility

With emerging equity markets having experienced their sharpest drop since the bull-run began in 2003, there’s little evidence of an immediate bounce-back. Investors are sitting nervously on the sidelines waiting for signs that fundamentals will reassert themselves and the markets will rebound.

“We’re still very cautious, we still don’t want to make any major bets, we’re concentrating on the stocks we’re sure of,” Dariusz Sliwinski, a fund manager at Martin Currie told Emerging Markets


The MSCI emerging markets index slumped 10.8% in May and fixed income has also suffered. The week ending 24th May saw the biggest outflows from EM bond flows since 2001, according to Credit Suisse. Mutual funds investing in diversified emerging markets were down 8.4% on average in the four weeks through May 26, according to investment researcher Morningstar Inc. In such an environment most investors have pulled in their horns somewhat.

“It’s a difficult call, obviously it’s only been two weeks but no one’s going to rush into emerging markets any time soon, people are more risk averse,” Alia Yousuf, a fund manager at Standard Bank told Emerging Markets. “I think the worst is over but there will be more volatility.” For the time being Yousuf is sticking with stable assets like Russian paper.

Martin Currie’s Sliwinsksi compares the current dip with a retrenchment two years ago when a 15% slide was followed by three or four months of volatility before markets resumed their upward march.

“One call I think I could make is emerging markets will still outperform developed markets this year,” Sliwinski predicts. He says he started easing back risky positions at the end of last year and for the moment is continuing a policy of very strict stock picking, focused particularly on domestic plays which will be insulated from a downturn in the international economy. Sliwinski likes companies in Brazil, central Europe, Korea and India but can’t find much of interest in Malaysia.

Turkey, Brazil, Indonesia, Hungary and Argentina have been among the hardest hit countries in recent weeks as hedge funds and other short-term investors pulled a range of positions simultaneously. Analysts predict markets’ performances will now begin to diverge as fundamentals return to the fore.

Corporate earnings in countries like Turkey, Indonesia and South Africa, may be at risk due to interest-rate hikes as falling currencies spur inflation, according to ABN Amro’s emerging markets strategist Maarten-Jan Bakkum.

On the other hand, “a few economies, such as Brazil, Russia and South Africa will not only recover, they should end the year in positive territory. It is still treacherous ground, but for those who know where to tread, these are intriguing markets,” Bakkum says.

Babak Minovi, who runs an emerging markets equities fund at Babson Capital, agrees that some markets still have further to fall, citing India and Turkey and describing Mexico as a “danger zone” owing to the forthcoming election. However, he brushes off concern of a permanent re-rating.

“Where there has been a permanent adjustment, for example in 1994 and 1997/98, there were major fundamental pricing discrepancies but in this case most emerging markets have very good reserves, low levels of debt, also corporates showing earnings growth and are not overvalued,” Minovi says. Companies in the far east are still undervalued, he contends, due to healthy domestic and export growth.

“The readjustment we saw served to let some of the air out of the tires of stock markets that had moved up substantially,” said Mark Mobius, Templeton Investments’ emerging markets manager. However, in Brazil, Russia, India and China, he notes, “given the reasonable level of valuations for a number of high-quality companies, we still cannot justify exiting any of these markets. In fact, we see the correction as an opportunity to buy further and we are quite sanguine about their prospects.”

One of the key determinants of how quickly emerging markets can bounce back will be US interest rates. Analysts predict that any correction in commodity prices will still leave oil producers and miners healthily profitable so attention is firmly fixed on how hard the Federal Reserve will have to apply the brakes to keep a lid on inflation.

Fed chairman Ben Bernanke’s explicit uncertainty about the future path of rates, following a period of absolute predictability, first gave global markets the jitters. And signs that US borrowing costs might move towards 6% or 7% from the current 5% rate would be a severe blow to emerging markets across the world.

The Fed has tightened rates in 16 straight steps since mid 2004. The European Central Bank has also begun its tightening cycle and the central bank of Japan is set to follow, sucking liquidity from world markets.

Some investors see the recent price adjustment as more than just a correctional blip on the path to convergence between emerging markets and their G7 peers. Raphael Kassin, head of emerging markets fixed income at ABN Amro Asset Management observes that the search for yield by greedy investors had led them to forget basic rules. The market downturn is a warning to those that preach of a structural reformation in local markets, he notes.

“Some of my fellow fund managers and I would say they’re irresponsible - they put too much money into markets that are too small,” Kassin told Emerging Markets in an interview. Local currencies have “been a fad and a lot of people have gone into it.”

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