Cracks surfacing in EM story

Emerging Markets (EM) stocks new post-2007 highs yesterday, as US 10 year yields stabilized around a  yield of 1.15%, while dollar lost some ground.  Instead, EM funds bought into the recovery story driven by Biden’s promises of mega-spending projects. Yet, several cracks are appearing in EM story, which are worth following.

The first of these is a warning by World Health Organization that even with vaccines, Covid-19 may still be around by the end of the year. News of China’s popular SinoVac  vaccine demonstrating only 51% efficacy needs to be watched, because led by Brazil and Turkey, this jab is the only one available to several Developing Nations. No vaccine, no recovery.

Even with the vaccine, investors’ darling Asia is witnessing a flare-up in infections. Local authorities in regions near Beijing are stepping up restrictions on social activity as new coronavirus cases grow.

The rise in Covid-19 cases and tighter government controls come just days before a World Health Organization team is set to arrive in China for research on the origins of the virus.

“The worsening coronavirus situation will impact economic activity,” says Ting Lu, chief China economist at Nomura.

The Japanese government is set to expand the state of emergency to more areas on Wednesday, according to local media reports. That comes after Japanese Prime Minister Yoshihide Suga recently declared a state of emergency in Tokyo and three other areas in a bid to stem a rise in coronavirus infections.  Malesia declared a nation emergency yesterday, as each day brings new of a new variant of covid-19, some of  which may be immune to available vaccines.

Yet, the biggest problems are in US-China  disputes and food prices. Regarding the latter,  global food prices hit a three-year high in 2020, a UN food agency said Thursday.

The Food and Agriculture Organization (FAO) said the food price index rose 3.1% year-on-year in 2020, averaging 97.9 – 2.9 points higher than 2019.

The FAO Food Price Index also soared 2.2% on a monthly basis, averaging 107.5 last month, driven by jumps in prices of vegetable oils, dairy products, meat and cereals, said the agency.

Higher food and energy prices have a bigger impact on CPI in Developing than in Developed Countries, meaning that Central Banks of former countries will have less room to cut rates.    It is also bad omen that Morgan Stanley cut its outlook for emerging market currencies overall to neutral from “bullish,” citing higher U.S. yields and little improvement in fundamentals.  More investment banks may follow suit, if dollar strength prevails.

Regarding US-China disputes, Trump is leaving behind a legacy of suspicion and high-handed punishment, which Biden will find difficult to heal, even if eh wants too.  Trump’s last decision could have a sudden and drastic affect on EM stocks:

The threat of a $1 trillion U.S. sanctions hit on the Chinese internet giants that have led emerging market stocks to their first record high since 2007 is overshadowing the rally, just as increased scrutiny from Beijing itself squeezes valuations.

U.S.-Sino tensions ratcheted up in recent days as outgoing President Donald Trump’s administration pushed through a ban on Americans investing in 35 firms it considers to be linked to China’s military.

Sources in Washington last week said Trump was considering adding Alibaba and Tencent, worth a combined $1.3 trillion, the second and third biggest EM stocks in the world and held by almost every major U.S. investment fund, to the list of banned firms.

Targeting China’s two most valuable companies would be the most dramatic step yet against the country’s firms as Trump seeks to cement his hardline policy against Beijing during his final days in office.

Goldman Sachs estimates that U.S. investors hold roughly $1 trillion of Chinese internet and tech stocks, or have U.S. listings known as American Depositary Receipts (ADRs) that Washington has also been clamping down on.

“To unwind 1 trillion of investment (if Alibaba and Tencent were removed) is a lot!” said Vivian Lin Thurston, a portfolio manager and Chinese equity analyst at William Blair Investment Management.

“It would be unprecedented,” she added. “It hasn’t happened before in any global market.”

While some funds would reallocate money to EMEA and perhaps even to LatAm, it stands to reason, other would switch to cash eyeing Biden’s China strategy, or to Developed Markets stocks.

This is the danger of investing in EM, it has few domestic stories, largely running on fumes of Biden spending plans and Fed actions keeping the dollar weak.


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Published By: Atilla Yeşilada

GlobalSource Partners’ Turkey Country Analyst Atilla Yesilada is the country’s leading political analyst and commentator. He is known throughout the finance and political science world for his thorough and outspoken coverage of Turkey’s political and financial developments. In addition to his extensive writing schedule, he is often called upon to provide his political expertise on major radio and television channels. Based in Istanbul, Atilla is co-founder of the information platform Istanbul Analytics and is one of GlobalSource’s local partners in Turkey. In addition to his consulting work and speaking engagements throughout the US, Europe and the Middle East, he writes regular columns for Turkey’s leading financial websites VATAN and and has contributed to the financial daily Referans and the liberal daily Radikal.