Some intrepid investors are seeing the wreckage of a $5 trillion fall in emerging markets as a buying opportunity.
The problems are all too obvious: Stocks have fallen below their 17-year average valuations. Bond yields in local currencies have risen to levels not seen since the 2008 financial crisis. Dollar bond spreads are approaching levels seen only in times of crisis.
After 15 months of capital outflows, emerging markets have reached an advanced level of risk pricing. For some money managers, this suggests it’s time to start purchasing again — not all at once, but in little, cautious measures. Still, the possibility of greater losses exists, particularly if China’s economy slows further or the Federal Reserve becomes more hawkish.
The aggregate equities values of the 24 countries categorized as emerging markets by MSCI Inc. have plummeted $4 trillion since a peak in early 2021, while Bloomberg indexes of dollar bonds and local-currency debt have each lost $500 billion since their highs. Investors are most concerned about Fed rate hikes and quantitative tightening, but rising inflation, new pandemic breakouts in China, and the crisis in Ukraine also play a role.
On Friday, a JPMorgan Chase & Co. gauge of the premium investors seeking to possess emerging-market sovereign dollar bonds over Treasuries reached 489 basis points. This is just below the 500 basis-point thresholds that caused a turnaround in 2015, but above the level that triggered one in 2011.
Local currency bonds are likewise flashing cheapness signs. The average yield on the EM Local Currency Government Universal Index has risen to 4.94 percent, above the downward sloping band it has varied in since 2008.
Meanwhile, MSCI’s developing market equities index has declined every month this year, extending its declines from 2021. Its price-to-book value ratio, which compares stock prices to balance sheets rather than profit-and-loss statements, dipped to 1.41 earlier this month, below the 1.47 average since 2005. By Monday, the gauge had returned to 1.48.
All of these indications do not necessarily indicate that emerging markets are ready for a rebound. A market disaster in the United States will almost surely drag emerging countries down with it, as will any escalation in monetary tightening or geopolitical tensions. Even absent those shocks, most investors believe emerging markets would suffer further losses before reaching a bottom.
Traders are looking for two signals before returning to emerging markets: a peak in inflation and a halt to the dollar’s surge. After six weeks of advances, the greenback lost ground last week, which should excite them. This week, they’ll also be seeking consumer-price data from at least eight developing countries, including Mexico and Malaysia. Data from the United States, such as personal consumption expenditure, will provide hints about Fed policy.