By Lauren Goodwin, CFA via Iris.xyz
There is no denying that emerging markets have had a difficult year. Investor sentiment towards EMs has deteriorated, EM currencies have weakened by 10-15% across the EM complex, and falling equity prices have added to the misery.
While redemptions out of EMs have been heavy, there are reasons to believe that the EM complex is oversold. For starters, most countries’ economic fundamentals have not materially weakened leading up to or through the selloff. While portfolio outflows have been meaningful, capital outflows – business investment in on-the-ground economic capacity – have been well within normal ranges. One reason for this is that multinational corporations are accustomed to currency and market volatility in less-developed countries and tend to take a “wait and see” approach to their business rather than abruptly change their international investment plans.
What’s more, price divergence between U.S. and emerging market equities is extreme. The 65-day performance spread between the S&P 500 Index and the MSCI Emerging Markets Index is flirting with the 5th percentile of all historical observations, suggesting that some mean reversion is likely.
At this time, we consider it unlikely that emerging markets issues will worsen substantially or propagate to the global financial system.
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