Investments Pour out of EM Funds, but Why?

The end of the emerging market boom doesn’t mean that these stocks are in a death spiral.

Emerging markets, which were investor darlings not long ago, suddenly aren’t. With the Federal Reserve poised to hike US short-term rates Wednesday, investors have pulled almost $1.5 billion out of EM exchange-traded funds in the past week, according to Bloomberg data.

But the reversal of EM fortunes may have run its course, with the EM downdraft ending.

The Fed’s likely move to lift its benchmark rate by a quarter percentage point is all but certain to further feed the rally in the US dollar, which is up. And that’s not good news for emerging nations, many of which are commodity-dependent.

The vast majority of commodities, such as oil, are traded in dollars. Rising oil prices, US-led trade protectionism, and geopolitical upheaval also are worrying EM investors afraid that these fledgling economies can’t stand the strain.

To be sure, the ETF dis-investment, and the market slump that prompted it, may have gone too far. Joyce Chen, head of EM investing for JP Morgan, told CNBC that it was “over-done.” According to a BNP Paribas research note, lagging growth in EMs this year will prevent any upside moves, although they “are in better shape than before to weather adverse shocks.”

Goldman Sachs, Citigroup, and Morgan Stanley have all issued bullish reports on EMs over the past few days. Research Affiliates has projected that EM stocks will lead developing nations’ offerings during the next decade, with an average annual return of 6.1% 

US rates remain well below historical averages. The dollar’s rise has been mild. The MSCI emerging markets index seems to have stabilized after a tumble, surging some 40% for two years up to it and peaking in late January. Since then, the index has tumbled by 11%, but leveled off starting in April.

Yes, the Fed’s latest round of tightening is ongoing, and connotes further action that will unfold over the next year or two. And the European Central Bank has signaled that it will join in later in the year, as the ECB winds down its massive bond-buying program. But the upward moves from near-zero, where they were lowered to combat the Great Recession, are gradual.

The Fed action expected Wednesday would mark the seventh boost since 2015. Yet its actions are well-telegraphed and tend to shock no one.

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