Foreign Policy magazine has noted that the real test of investor sentiment lies in emerging markets, the asset class most sensitive to sudden changes in investors’ perceptions of risk. In May 2013, the mere hint of a gradual withdrawal of the Fed’s monetary stimulus led to sharp declines in the bonds and stocks of emerging markets. After a five-month-long rally, developing economies are again showing signs of strain as over the past month, emerging market stocks have fallen 2.3% (and Latin American shares 5%) compared with a 1.5% rise in the benchmark S&P 500 index.
However, emerging market stocks have had a good run of late and were due for a correction at some point while investor sentiment towards emerging markets is not as bleak as the headlines suggest because foreign investors have been increasing their holdings of EM local currency bonds this year, particularly in Asia and Latin America, but also in Turkey, which is still deemed to be one of the riskiest EMs.
Moreover, developing economies are a lot more stable and credit-worthy than they were during the 1990s with most emerging markets now have investment-grade credit ratings thanks to significant improvements in their economic fundamentals over the past 10 to 15 years.
Finally, domestic institutional investors, such as Mexican pension funds and Asian insurers which have grown in recent years, hold the bulk of developing countries’ bonds, helping shore up emerging markets when flighty retail investors from developed markets decide to exit the market.
To read the whole article, The Emerging Market Stress Test, go to the website of Foreign Policy.
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