Emerging Markets Offer No Shelter From the Storm

Though the market panic over the past two days is broadly seen as having been sparked by fears about the European economy, smaller developing countries haven’t escaped the rout.

Stock markets in the United States and Europe recovered somewhat on Thursday, but volatility like Wednesday’s frantic selloff — Wall Street’s worst single day since 2011 — is expected to continue. That’s because investors are still on edge, worried that markets have been driven up to highs that don’t match global growth prospects.

"I don’t think the market reaction was warranted," said Win Thin, global head of emerging-market strategy at Brown Brothers Harriman & Co. "But I think people are very nervous."

And those concerns aren’t restricted to Europe, even though worry that the bloc could be headed for another downturn was a big factor in setting off the stampede. It’s been a bad week for emerging-market countries — like Brazil, China, and South Africa — and U.S. markets as well. After settling lower Monday and Tuesday, the Dow Jones industrial average plummeted 460 points on Wednesday before rebounding to a 1.1 percent loss for the day. By midday Thursday, the MSCI Emerging Markets Index was down 1.1 percent and individual countries suffered as well, with Brazil’s Bovespa index down 2.5 percent, Dubai’s index down 5 percent, and Hong Kong’s index of Chinese companies down 1 percent.

In Europe, the hardest-hit countries were the bloc’s emerging economies, such as Portugal and Greece. Concerns that European policymakers won’t be able to right the economy sent German stocks down 2 percent and Italian stocks down 4 percent, though both bounced back to erase most of those losses. The weaker European economies were not as lucky. Greece’s ASE Index fell 6 percent and Portugal’s PSI 20 lost 4 percent, according to Bloomberg.

Though fears about Europe were part of the panic, there’s been plenty of bad news to go around this week. A new case of Ebola in the United States sent airline stocks tumbling again, as they did earlier this month when the first Ebola patient was discovered in Dallas.

Emerging markets — smaller economies that are newer to global markets — were once thought of as reacting to different events than more developed economies, Thin explained. But now they’re much more interconnected to the rest of the world thanks to global trade. Countries in Africa rely on China to buy commodities such as oil; China relies on Europe and the United States to buy exports such as electronics; and on and on.

"They’re along for the ride," said Thin. Emerging markets are "going to remain on the back foot going into next year until we sort out how bad global growth really is," he said.

On top fears about a global slowdown, emerging-market investors are also wary that a change in Federal Reserve policy could cause a flight of capital to safer assets. The Fed’s low interest rates in the United States since the financial crisis had pushed investors to look for higher-paying, riskier assets abroad. Now, economists are worried about a reversal that would see investors fleeing emerging markets.

Gabriel Sterne, head of global macro investor services at Oxford Economics Ltd., has been watching emerging-market bonds.

"Bond markets got absolutely massacred and fairly indiscriminately," he said. Investors know that prices for emerging-market assets have gone up too high, so they’re easily spooked, Sterne said.

"I think things are overpriced and lots of people out there think things are overpriced," Sterne said. "They’ve all been sitting there nervously and then when something happens like what’s happened in the past few days, everyone surges for the exit."

And that sends prices plummeting. The only silver lining, says Sterne, is that the financial crisis spurred governments to toughen up the banks, meaning the financial system should be able to weather the storm, even if individual investments suffer.

"It’s painful on wealth but probably the banking system is OK, so the world’s not going to fall apart," he said.