We all know that when it comes to society, generalizations are dangerous and unacceptable. As history has progressed, people (in most of the world, at least) have thankfully come to realize that people are people, regardless of race, religion or any other identifier that we may place on them. Each has their own unique talents and faults and each their own balance of good and bad, no matter which group we may attempt to place them in.
When it comes to markets, however, we love to put things in categories; large cap/small cap, tech/industrial, consumer staples/consumer discretionary... the list of divisions is seemingly endless.
As with people, these groups make things more orderly in some ways, but are inherently unfair. Just because Wal-Mart (WMT) had a bad quarter that doesn’t necessarily mean that Costco (COST) did too, but that stock will drop on bad earnings from WMT. Problems in Detroit don’t mean that North Carolina Munis are in trouble, but a hint of a municipal bankruptcy will see the whole market come under pressure.
This kind of contagion is yet another example of something that I refer to regularly; markets overreact, particularly to bad news. We are seeing that now in emerging markets, and that sets up an opportunity.
So far this year, the “collapse” in emerging markets has been the big financial story. First, let’s put a little perspective on this "collapse."
Using the Vanguard Emerging Market ETF (VWO) as a proxy for those markets as a whole, we can see that from the end of last year to yesterday’s close, VWO lost 8.4%. Now an 8.4% drop in a month is nothing to be sneezed at, but is it really such a disaster in a very volatile area? If that causes you to lose sleep then I would venture to suggest that you shouldn’t have had that much money in emerging markets in the first place.
There are problems, of course. It is easy to say with hindsight, but when Turkey’s Central Bank began intervening to support their currency the writing was on the wall. The forex market sees intervention such as that as a sign of weakness and an opportunity. Once the markets smell trouble there is little that a country’s authorities can do; if the Turkish Central bank thinks it can overwhelm a market that has successfully taken on the Bank of England, for example, it is a little naïve.
The initial pressure on the currency wouldn’t have come if there weren’t problems, however, and the problems came from the fact that the world is re-adjusting after a period of low interest rates. Put simply, as the return for investing in less volatile developed markets increases, so money moves there from the more risky developing world, putting downward pressure on an emerging market country’s currency.
Turkey, then, has its problems, as do Argentina, Russia and others, but the likelihood is that the contagion from those problems will result in an opportunity elsewhere.
Just such an opportunity may well be shaping up in Mexico. The iShares Mexico ETF (EWW) has been dragged down with the others and has also lost around 8% this month. Remember, the root cause of this problem for emerging markets is rising interest rates around the world.
Those rates are edging higher as the Federal Reserve here in the US begins to exit QE and that is possible because economic conditions here are improving. Now consider that Mexico does around 80% of its international trade with the US. Does it seem right that the Mexican market is being pounded because its biggest trading partner is strengthening?
No, it doesn’t to me either. As I hinted at earlier, any investment in an emerging market has a high degree of risk, and buying EWW at these depressed levels is no exception. It could be that January has just been the beginning of a bad year for emerging markets as a whole and the worst is yet to come, but I doubt it.
It looks to me as if Mexico has suffered from a kind of collective market prejudice that treats all emerging markets as the same in times of trouble.
In financial markets, just as with people, that type of attitude may temporarily drag the good down with the bad but sooner or later reality will intervene and the good will recover. Mexico may not fully escape the turmoil and may not be without problems, but it is not Turkey.