Emerging market stocks rebound after Fed raises interest rates
Emerging market stocks rebound after Fed raises interest rates
20 Dec 2015

Emerging market stocks staged a relief rally on Thursday, rebounding from six-year-lows, as the US Federal Reserve indicated that further interest rate increases would be gradual.

On Wednesday the Fed raised rates for the first time in nine years.

Investors scooped up shares not just in emerging markets but everywhere around the world, confident that the tap for cheap cash that has boosted risky assets for the past seven years would probably not be shut off as quickly as had been thought by many.

In a widely expected move, the Fed raised its benchmark rate by 0.5 per cent on Wednesday, but the Fed chair Janet Yellen emphasised that further increases would be gradual as the world’s largest economy continues to recover from the 2008 financial crisis.

The MSCI Emerging Market Index, a benchmark measure of developing market stocks, rallied 1.1 per cent as investors collectively breathed a sigh of relief.

But of more concern to long-term investors is that emerging currencies continued to decline against the US dollar, as did oil and other commodity prices – key gauges of the health of many emerging economies, and also a reflection of global economic demand for metals and energy that are needed to build and fire up consumer goods such as automobiles.

Going forward and looking into next year, investors and economists are split as to the fortunes of currencies, stocks and bonds of developing markets.

On one hand, the bulls contend that the dollar has appreciated too strongly against emerging-market currencies in the past couple of years and will start to give back some ground, while the bears maintain that the problems of emerging-market companies will get worse as the greenback remains strong and servicing debt denominated in that currency becomes more difficult.

The IMF warned this year that emerging market companies that went on a debt binge in the aftermath of the low interest rate period during the global financial crisis may find it increasingly difficult to pay back debt, as economic growth slows and the cost of funding increases.

Emerging-market debt stands at about US$18 trillion from $4tn in 2004, according to the IMF. And that is causing concern beyond the mandarins in Washington.

“We are bearish on emerging markets but the hike has not been the trigger point for that,” said David Kohl, the chief currency strategist at Julius Baer, a private Swiss bank.

“We think emerging markets have deep-rooted structural problems after a wonderful decade of really good growth. This is not unique to emerging markets and even in advanced economies after a decade long of debt-driven growth run into problems. In the US with subprime, they had six years of debt-driven growth and then they had problems.” It has been a bad year for emerging markets for sure. Investors pulled money at the fastest pace since the financial crash of 2008 as a collapse in commodity prices put the brakes on growth.

Raw materials in these countries are relied on for funding government spending and firing up economies.

The MSCI Emerging Market Index has dropped 17 per cent this year as a result.

Emerging markets have also been unloved because of political turmoil in countries such as Russia, Brazil and Turkey, and the relatively sluggish GDP growth in China, the world’s second-biggest economy, and a net energy importer.

More than $60 billion has been taken out of emerging markets equities this year, according to EPFR, a global compiler of fund data. Many investors, however, despite the depressed prices, see value in this battered asset class and warn that a continued decline in the economies of developing nations, which account for more than 40 per cent of global growth, may be a harbinger of overall global economic recession. “I think overall 2016 will have higher demand than the world is perceiving right now,” said Steen Jakobsen, the chief investment officer of Saxo Bank, the Danish investment bank.

“I think people are too negative on China, people are too negative on oil prices overall. If the dollar continues to strengthen, not only will emerging markets do very poorly, but the world is going to move very close to what will be perceived to be a recession.”