A 10% slide in emerging-markets stocks could be a signal that the bull run has come to a grinding halt.
The emerging-markets (EMs) boom looks to be over. The MSCI EM Index has slid by 10% from its early May level and EM bonds have posted a similar drop. The South African rand and the Indian rupee have fallen by 10% and 7% against the dollar respectively in the past six weeks. The exodus of capital from EMs has fuelled fear of potential crises.
Sentiment has switched largely because of the US Federal Reserve's hints that it will slow the pace of its quantitative-easing programme. That raises the prospect of higher yields as monetary policy is tightened, which would push up the dollar. So US assets have become more appealing compared to their riskier EM counterparts. Disappointing recent growth figures, the related downturn in commodities and political upheaval in some states, such as Turkey and South Africa, have also hit confidence.
"Even the shallowest of turns in America's monetary cycle is amplified" in EMs, notes The Economist. Market interest rates are rising in some countries as foreign buyers for local bonds dry up. Foreign money draining away from EMs undermines growth prospects, while a slide in the currency can fuel inflation, precluding an interest rate cut to boost growth. Indeed, sometimes a central bank will be forced to raise interest rates to make the currency more appealing: witness Indonesia's move last week.
The countries most vulnerable to capital outflows are those with current-account deficits: they spend more abroad than they take in, and need foreign cash to bridge the gap. The foreign money can disappear especially quickly if it is made up mostly of investments in stocks and bonds so-called hot money' that can leave easily rather than foreign direct investment projects. Enter Turkey and India, whose currencies have been among the biggest fallers in recent weeks.
Another problem in the past has been a sharp slide in local currencies causing a surge in the value of foreign-currency debt, says Capital Economics, a consultancy. The recent flood of capital, however, went mostly into local-currency bonds, as The Economist points out. But there is still ample scope for panic selling in EMs to cause severe trouble. If only a fraction of the estimated $4trn that has flowed into EMs since 2009 "is yanked out by jittery investors, it would turn a sell-off into a rout".