The Great Asian Sell-Off

Don’t call it a crisis — not yet, at least. Investors have been fleeing markets in South and Southeast Asia, and share values and currencies have been tumbling. But some of the drop might not reflect underlying changes in these countries’ economies, so bargains may be there for the taking.

The dip in India’s rupee has been grabbing headlines lately (including mine last week), but other currencies are on the rocks as well. The Thai baht has slipped by about 10 percent versus the dollar since April, and the Indonesian rupiah is about 12 percent lower. Of course, much of this trend stems from the strengthening of the dollar, with the U.S. Federal Reserve gradually ending its huge purchases of securities and slowing the expansion in the money supply.

Meanwhile, Indonesia’s main stock market index has dropped by about 20 percent since May, and Thailand’s is down about 17 percent. Stocks in the Philippines had lost 20 percent within a month of their peak in May, but now they have stabilized with losses of about 12 percent. Indian stocks have plunged by more than 10 percent just since July.

Dips in exchange rates and stock indexes don’t always go together. All other things being equal, share prices might be expected to rise when currencies lose value. With no change in the real return to capital — that is, the return generated by companies’ assets, adjusted for inflation — the price of a share to a foreign investor should remain the same. Indeed, these offsetting moves have happened to some extent in Japan under its new inflationary monetary policy; as the yen has slumped, the Nikkei index has shot skyward. (To be sure, the optimism generated by the new policy has helped stocks outpace the currency’s decline.)

But this offset doesn’t occur when foreign investors suspect that the return to capital is dropping; then the sell-off is all-encompassing. In Asia, investors are first selling their financial assets and then selling the proceeds — the rupees, baht, rupiahs, and pesos — for other currencies.

One nagging question arises in the midst of this havoc: Why dump all the countries at once? There’s isn’t just one explanation for the widespread destruction of value in Asia. Each country has its own issues, just as the crisis in the eurozone had causes that varied from budget deficits to bank failures. Indeed, global investors have supposedly gotten better at distinguishing between emerging markets, thanks to better transparency and access to information. The old fears of "contagion" in financial crises, which became especially notorious during the Latin American crashes starting in the 1980s and the Asian crisis in the late 1990s, have somewhat abated. Yet because many investors put large groups of emerging markets in the same boat, the markets must still sink and sail together.

Investors usually see emerging markets as risky, and on average they are: Corruption, conflict, weak property rights, and other problems are all more common in developing countries. Investors also tend to group emerging markets together in their portfolios, sometimes even combining enormous regions spanning whole continents. Fidelity’s EMEA fund, for example, covers "emerging Europe," the Middle East, and Africa. By my count that’s about 80 countries, and they could hardly be more diverse. What does Turkey’s economic future have in common with Gambia’s? Ask Fidelity.

Given this kind of bundling, consider what happens when one emerging market runs into problems, like the steep drop in forecasts for growth in India that I wrote about last week. If investors decide India is riskier than they thought, then they have to reduce risks elsewhere in order to maintain balanced portfolios; in fact, big investors like pension funds are often required to do this. And what’s the easiest way to reduce risks? By getting out of emerging markets.

So when one emerging market gives fright to investors, they have a natural tendency to pull back from other emerging markets as well, even if the other markets have little in common with the one having problems. This seems unfair, and it is. Even in this era of unprecedented information and transparency, contagion still occurs, and it does so almost automatically.

It’s true that countries in Asia are experiencing some common challenges in the short to medium term. China is a major source of demand in the region, and it has been growing more slowly of late. Japan is also an important trading partner for many of its neighbors, and forecasts for its growth are still anemic despite the country’s new economic policy.

But it’s hard to believe that the long-term growth paths of Asian countries have taken such a negative turn just in the past few months. The price of an Indonesian share to an American investor, for instance, should be proportional to the value in today’s dollars of all the returns generated by the company from now until its dissolution. Has this total really dropped by more than 30 percent just since May? Or was it a bubble in the first place, inflated by hype and investors frustrated with low returns in the West? With an automatic pullback in emerging market portfolios, neither explanation can justify the sell-off completely.