EMERGING MARKETS
of the US economy, but also in the combination of decelerating economic growth and rising political risk across a spectrum of EM countries. As examined in our previous report, Decelerating BRICs Face Structural Challenges, from December 9, 2013, economic growth in the four largest EMs (Brazil, Russia, India, and China) has been slowing, with weighted average real GDP growth of 8.2% in 2010 declining to an estimated 5.5% in 2013 and a forecasted 5.1% for 2014 (Figure 2). From a political risk perspective, challenges
included the Syrian Civil War, which was complicated by the nerve gas attacks and related US- Russian diplomacy. There were demonstrations in the plazas of Turkey over development plans, as well as a scandal reaching high into the Government. Middle class residents took to the streets of Brazil to demand improved government services, even as the Government was spending generously on the infrastructure for the 2014 World Cup and 2016 Olympic Games. In Thailand, political unrest threatened the electoral process. India’s election campaign was heating up with the possibility of a major change in political power. Argentina experienced significant inflation, a currency devaluation, and overall political confusion. Ukrainian political tensions became violent. Some of these tensions eased while others gained momentum over the year, and through it all the US equity market kept on rising to new record highs. The juxtaposition of a powerful rally in US
equities set against decelerating economic growth and rising political risks in many EM countries provided the foundation and incentives for many global asset allocators, such as pensions, endowments, sovereign wealth funds, etc., to shift their asset allocation policies in the direction of US equities and other mature industrial markets, and away from EM countries. This asset allocation shift hit both EM equities and currencies. With any asset allocation shift from a relatively less liquid set of exposures or markets to much more liquid markets brings with it another set of dynamics. When a growing consensus of market participants decide that they are “off” an asset class, the effects of a sell-off are exacerbated by limited liquidity, which heightens the appearance and reality of contagion. That is, when investors feel the urge to take off
risk in a specific asset class, or market conditions dictate a shift of investment climate, a first instinct is to cut positions across the board within the asset class in question. This often happens when large quantities of assets are managed by third parties for a larger fund or institutional investor. For example, if a large global pension fund or
sovereign wealth fund decides to allocate away from EM country exposures, this likely means that
Figure 2: Equity Performance in 2013 in Local FX Terms
-‐20% -‐10% 0% 10% 20% 30% 40%
29.6%
9.0%
-‐2.2% -‐6.7% US China Source: Bloomberg Professional
it will be withdrawing money from third-party EM asset product managers, who then must quickly raise cash to return to their investors. Often, this means there is little differentiation in what is sold. Realistically, when a portfolio or fund manager is cutting positions, this is done in a sell-what- you-can and quickly-as-you-can format, with the liquid assets being the first to fly. Because the most
Figure 3: Average BRIC Real GDP Growth Decelerating
9% 8.2% 6.8% 6% 5.6%
EsCmate 5.5%
Forecast 5.1%
-‐15.5% Brazil
India Mexico
-‐5.0%
MSCI EM Equity Index
3%
0% 2010 2011 Source: Bloomberg Professional
liquid exposure in an emerging market is often the corresponding currency, and because sales of any locally-denominated securities will also involve a currency sale to convert the proceeds back to US
... when a portfolio or fund manager is
cutting positions, this is done in a sell-what- you-can and quickly-as-you-can format
dollars or some other major currency, the sell-off of EM currencies and assets often has the appearance of depreciation contagion. During this phase, correlations rise among pairs of exposures within the asset class. Typically, the initial rush is followed by a more
March 2014 67 2012 2013 2014
Real GDP Growth (Percentage Change Year to Year)
Percent Change in Equity Index Level Dec 31st 2012 to Dec 31st 2013
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