By SNW Asset Management via Iris.xyz

Emerging market weakness and financial market contagion risks are again in the news.

In our view, this bout of emerging market weakness stems from a number of causes: a stronger U.S. dollar reflecting Federal Reserve rate hikes, an elevated exposure to dollar denominated debt in many emerging market countries (notably Turkey, South Africa and Argentina), and a continuing economic slowdown in China.

A slowdown in China is a bigger factor in this episode of emerging market risk than in the past. China now contributes about 15% to the global economy compared with about 3% two decades ago. And, importantly, China contributes more than 30% to all global growth. Today, when China sneezes, many of their emerging market trading partners catch a cold.

We can see this weakness and contagion risk in emerging market currencies, which are down 8.6% since March. Additionally, emerging market equities are approaching bear market status; the MSCI index is down close to 20% since recent highs. Finally, we have all seen the charts on copper, which is down about 20% in just the last few months. Copper didn’t catch a cold, it got the flu!

The concern is that weaker emerging markets will lead to a broader based sell off in developed markets, and could eventually lead to material weakness in high grade credit markets. This would be classic contagion.

To date, this has not occurred. With very low unemployment, cyclically high GDP, record breaking corporate profits and contained inflation, the U.S. economy continues to perform well. We are doing better than most of the world. Responding to these good fundamentals, the stock market is setting new highs, with two new trillion-dollar market capitalization companies, one located just across the street from our offices in Seattle!

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