Not that long ago, many emerging market countries were
struggling with the "problem of plenty". Ultra-low interest rates
in the developed world coupled with higher growth prospects in
these countries led to a surge in capital inflows. Massive
inflows complicated monetary management and led to appreciation
of currencies. (Read:
Best ETF Strategies for 2014
WISDMTR-KR HE (DXKW): ETF Research Reports
ISHARS-EMG MKT (EEM): ETF Research Reports
MKT VEC-EGYPT (EGPT): ETF Research Reports
ISHARS-MS POLND (EPOL): ETF Research Reports
ISHARS-MEXICO (EWW): ETF Research Reports
ISHRS-MSCI TURK (TUR): ETF Research Reports
MKT VEC-VIETNAM (VNM): ETF Research Reports
VANGD-FTSE EM (VWO): ETF Research Reports
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The beginning of the end of cheap-money era is now causing
turbulence in these markets. As foreign investors head for exits,
currencies of countries like Argentina, Turkey, Brazil and South
Africa plunged to their multi-year lows and their stock markets
Further, many emerging countries profited from China's enormous
appetite for commodities in the past few years. Concerns
about slowing growth in China as well the health of its huge
shadow banking system are causing tremors in commodity exports
For some countries, factors are mostly internal-woes of their own
making. Current crisis just exposed the structural problems that
already existed in these countries. Their policymakers failed to
address those severe problems when the going was good.
5 ETF Prections for 2014
Unfortunately, in times of panic, inventors tend to lump and
punish all emerging together. But looking at slightly longer-term
picture, there may be some pockets of opportunity within the
space. Investors need to focus on macroeconomic fundamentals and
discriminate the stronger economies from the weaker ones.
A look at the Recent Performance
The broader emerging market ETFs Vanguard Emerging Markets ETFs (
) and iShares Emerging Markets ETF (
) are down more than 8% this year and many have fared
worse. iShares Turkey ETF (
) and Market Vectors Russia ETF (
) are among the worst performers-losing more than 11% this year.
On the other end of the spectrum, some smaller emerging
markets/frontier markets did very well. Market Vectors'
) and Vietnam (
) ETFs are up close to 11% this year.
Central banks in many countries rushed with several measures
including rate hikes to stem the slide of their currencies and
halt the exodus of foreign capital.
Turkey announced a massive rate rise but the respite for the
beleaguered currency was rather short-lived. Indian rupee
fared only slightly better after the rate hike. Brazil and South
Africa did the same but the actions failed to help their
Which Countries are Most Vulnerable?
In my view, investors should avoid emerging countries from the
following four groups.
: Countries that are dependent on foreign capital to finance
their external deficits remain most vulnerable to the Fed's
tapering plans. Turkey, South Africa, Brazil and Indonesia look
most risky looking at their current account defects and external
: Argentina and Venezuela are the easiest to classify in this
group. Turkey and South Africa come to mind next. BRIC countries
also suffer from some structural issues that will continue to
cause problems going forward.
: All "Fragile Five" countries-Brazil, Turkey, India, Indonesia
and Turkey-have general elections this year, which will keep
these markets volatile. Countries like Turkey, Ukraine and
Thailand are also facing political unrest, which makes their ride
Dependence on China
: Slowing demand in the world's largest consumer of commodities
does not bode well for countries like Brazil, South Africa and
Indonesia. They have had their days in the sun and the picture
looks cloudy now.
Is it a repeat of 1997-98 Possible?
I don't think that a full-blown financial contagion is on the
horizon for emerging markets, even though volatility may continue
to be high for quite some time.
The financial situation in emerging markets was very different in
1997-98. Many emerging countries have since accumulated large
holdings of foreign exchange reserves, as they tried to halt the
rise of their currencies in the face of strong capital inflows
during the past few years.
Further, most of them have flexible exchange rates unlike in 1997
when countries with fixed exchange rate regimes were forced to
devalue their currencies. Their financial markets are also much
more mature now.
Any Bright Spots among Dark Clouds?
When the developed world was growing at a sluggish rate, domestic
consumption driven developing economies like India, Indonesia and
Turkey did pretty well. They may not do so well when domestic
growth is slowing and currency woes will result in further
decline in domestic demand.
On the other hand, countries that are leveraged to the growth in
the developing world are likely to do better. The outlook for
Mexico and South Korea has improved with that of their key export
Will the Mexico ETF shine in 2014?
iShares Mexico ETF (
) looks quite promising as of now due to significant reforms
introduced by the Nieto administration and improving growth
picture. Mexican Peso remains among the best performing emerging
Encouraged by improving investment climate and significant
reforms undertaken by the government, many large multinationals
have announced huge investments in the country recently; the list
includes PepsiCo ($5.3 billion), Cisco ($1.3 billion) and Nestle
Looking at emerging Europe, Poland looks good, with its
unexpectedly strong economic growth, solid fundamentals and
rather resilient currency. Investors could consider iShares
Poland ETF (
) or Market Vectors Poland ETF (
South Korea, with its record current account surplus, massive
foreign exchange reserves and excellent institutional framework,
could deliver excellent returns over long-term. WisdomTree Korea
currency hedged ETF (
) is worth a look.
The Bottom Line
Emerging markets account for about 55% of global GDP in PPP
terms. So a prolonged turmoil in these countries will impact the
global financial markets. It is thus no surprise that spooked
investors have been abandoning risky assets and seeking refuge in
"safe havens", leading to a sudden rise in the popularity of
treasuries and gold.
Investors need to remember that one size does not fit all
emerging markets. Current sell-off has created some long-term
opportunities for investors who can differentiate between
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