Emerging Markets   |   March 1, 2018

Emerging Markets and the Return of Volatility

After experiencing a closing low in early January, the VIX – which is the common measure of volatility in the US stock market – began a moderate climb towards the end of the month prior to exploding on the upside in early February. In the last two months, the VIX has traded at levels not encountered for two years, and not consistently exceeded since 2011. In such an environment, many would expect Emerging Markets (EM) equities to underperform (as they did from 2011) and the US dollar to gain notably (as it did from 2011).

So far this year, however, this has not been the case. Emerging Markets have remained encouragingly stable, with a flat return in USD terms. This is in line with major global equity markets, while the average EM currency has fallen only marginally against the US Dollar.

The main cause of this bumpy environment is the fear that rising growth in the US will lead to higher inflation. This would force the new Federal Reserve Chair Jerome Powell to raise policy rates by more than the market originally thought.

Adding to this more cautious environment has been the imposition of steel and aluminium tariffs by the US on China and other economies, affecting $50 billion worth of Chinese exports. This has been followed by retaliatory measures of a similar volume for China’s imports from the US.

What this means for Emerging Market equities

In our view, the investment case for the asset class remains resilient, essentially for the same three reasons we have remained bullish over the course of the last two years:

  • Emerging economies are recovering.
  • Corporate profits are growing at a faster rate than experienced for most of the last decade.
  • EM currencies remain competitive despite their recovery over the past two years.

In addition to this, the asset class is inexpensive relative to its own past and cheap relative to US equities in particular. It remains under owned by international investors.

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