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Archived News  21/09/2018

Emerging Markets: Catching a cold?

Ewan Millar, Senior Investment Manager at Cornelian Asset Managers, checks the financial health of Emerging Markets.

Arguably, the most striking aspect of recent equity market performance, when surveyed from a regional perspective, is the large disparity between the various regions.  Notably the US (+12% YTD) and Emerging Markets (-10% YTD).  Periods like this, however, are not altogether uncommon.  In 2015 the MSCI Emerging Markets Index fell 12% whilst the S&P 500 was up 5%.  Both of these spells of significant Emerging Market underperformance coincided with a period of material US Dollar strength.

When the dollar goes up, so does the size of that debt and the cost of servicing it.

So why does a strong US Dollar have such a detrimental impact on Emerging Markets?  Firstly, a strong dollar has a negative influence on commodity prices and many Emerging Market economies have an over-dependence on commodity exports.  Secondly, and more importantly, in order to be able to access international debt markets Emerging Market economies borrow in US Dollars and have large external dollar denominated debts. When the dollar goes up, so does the size of that debt and the cost of servicing it.

Amongst the Emerging Markets, there have been a number of individual nations that have attracted particular focus of late.  Turkey is facing a currency crisis (the Turkish Lira has fallen 38% versus the US Dollar this year) exacerbated by the economic leadership shown by President Erdogan and by the ongoing political feud with the US.  Turkish stocks have fallen by 50% this year.  In Argentina the currency has collapsed amid rampant inflation and the government has been forced to turn to the IMF for a bail out.  The Argentinian stock market has fallen by over a half.  The South African economy officially entering recession has heaped more woes on an already beleaguered asset class.

It is difficult to talk about Emerging Markets without talking about China.  Although debt levels continue to increase at what appear to be unsustainable levels, authorities are addressing the issue.  The economy continues to grow at an enviable rate, from a western perspective, and the modernisation and development of the country continues apace.  The stock market, however, has fallen 11% year to date - China also having come under pressure from the negative sentiment effect of the strong US Dollar.  Well-founded concerns surrounding the vociferous trade dispute with the US has led to further selling.

Any economic slowdown remains country specific and can largely be explained by individual policy errors within those countries.

We believe the Emerging Market crisis will be contained and not spread to the rest of the world. Any economic slowdown remains country specific and can largely be explained by individual policy errors within those countries.  Developed nation equities remain underpinned by the global economic expansion and strong corporate earnings growth.  What the recent episode of underperformance does highlight is the risk inherent within the Emerging Market asset class.

At Cornelian we take a cautious approach to Emerging Markets due to their higher risk, as increased risk in itself does not necessarily lead to increased returns.  A considered and effective approach to risk management is ultimately what leads to enhanced through-the-cycle returns.

Sources:  Factset, MSCI.  Returns in GBP and correct at time of writing

Cornelian Investment Team

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