What Impacts Emerging Markets

What Impacts Emerging Markets

 

Emerging markets continue to be an asset class that many investors are frustrated with performance wise. Although it may feel like emerging markets (both debt and equity) are always down and have negative returns, this is simply not true.

This is certainly a more volatile asset class and that may add to the perception given more recent returns, however, over longer time periods (3, 5 and 10 years) emerging markets have provided positive total returns. Furthermore, 2017 annual returns were exceptional, topping both domestic and developed international returns, but how quickly this seems to be forgotten.

Below highlights this fact when looking at period returns for both emerging market equity and debt indices as of 9/30/2018.

Index Total Return YTD

Total    Return      1 Yr

Total  Return Annlzd     3 Yr

Total  Return Annlzd    5 Yr

Total  Return Annlzd  10 Yr

Annual Return 2017
MSCI Emerging Market Equity (7.39) (0.44) 12.77 3.99 5.76 37.75
JPM Emerging Market Bond Global USD (3.04) (1.92) 6.04 5.38 7.54 10.26

 

The U.S. dollar has a big influence over emerging markets. Typically, a stronger dollar will dampen emerging market returns and a weaker dollar is a boon to emerging markets. Interest rates can also have an effect. The following breaks down why this relationship exists, in general, between the U.S. dollar and emerging markets.

  1. Cost of servicing dollar-denominated debt
    • Most EM countries borrow in U.S. dollars due to underdeveloped local capital markets – meaning not enough local investors in the local currency. Because of the lack of local investors, this forces countries to look to larger capital markets for external debt financing. Until more recently, dollar funding has been cheap via a weaker dollar and lower interest rates. This has changed some as the dollar strengthens and interest rates rise.
  2. Commodity prices
    • Globally, commodities generally are traded (priced) in dollars. A stronger dollar reduces EMs buying power of commodities; however can benefit commodity exports of that country. For the most part, EMs are net exporters of commodities with some exceptions being China, India and Turkey.
  3. Economic growth
    • A big reason most invest in emerging markets is the belief that over the long-term these countries will exhibit faster growth than developed countries. Investment flows can certainly have an impact to EMs. When there is concern over economic growth of EMs this can lead to capital outflows, creating volatility and diminishing short-term returns. Headline risk can be big here.

While it may be tough to endure times like this, we believe that maintaining exposure to emerging markets is important for the long-term success of a globally diversified portfolio.

 

Washington Trust Bank believes that the information used in this study was obtained from reliable sources, but we do not guarantee its accuracy. Neither the information nor any opinion expressed constitutes a solicitation for business or a recommendation of the purchase or sale of securities or commodities.

About The Author

Derrick is a Portfolio Manager of Manager Selection and Due Diligence for Washington Trust Bank’s Wealth Management & Advisory Services. He is responsible for all external investment manager analysis, selection, monitoring and retention.