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Emerging-Market VIX Surges Most in Two Years on Selloff

By Nikolaj Gammeltoft and Callie Bost
January 27, 2014 3:48 AM EST 6 Comments
Turkey's Lira Currency
Turkey's Lira Currency

Equity volatility from India to Brazil and Turkey jumped the most in two years as turmoil spread across global markets amid a selloff in developing-country currencies and growing concern over China’s economy.

The Chicago Board Options Exchange Emerging Markets ETF Volatility Index rose 40 percent to 28.26 last week, the biggest increase since September 2011, according to data compiled by Bloomberg. Bearish bets outnumber bullish ones on the underlying exchange-traded fund by the most since July with about 60 percent more puts than calls. Developing-nation stocks extended declines from a 4 1/2-month low today, with MSCI’s Emerging-Markets Index losing 1.7 percent by 4:34 p.m. in Hong Kong.

The devaluation of Argentina’s peso, data signaling a possible contraction in China’s factory output and declines from the Turkish lira to the South African rand shook investor confidence. Emerging-market equities have tumbled since the Federal Reserve signaled in May that it could start scaling back bond purchases that boosted demand for higher-yielding assets.

“There’s concern that the downtrend may continue,” Walter “Bucky” Hellwig, who helps manage $17 billion at BB&T Wealth Management in Birmingham, Alabama, said by phone Jan. 24. “Protection is being purchased or bets are being made that it will.”

The MSCI emerging-markets gauge fell 2.3 percent to 949.90 last week, extending this year’s slump to 5.3 percent. The European equity benchmark lost 3.3 percent, while the Dow Jones Industrial Average (INDU) sank 3.5 percent for its biggest weekly decline since May 2012.

Global Markets

The global selloff resumed today with the Hang Seng China Enterprises Index of mainland Chinese stocks listed in Hong Kong slipping 2.2 percent to its lowest close since Aug. 28. The Kospi index in Seoul slid 1.6 percent. Japan’s Topix Index (TPX) tumbled 2.8 percent, the most in almost six months, fueling a 2.1 percent decline in the MSCI Asia Pacific Index. The regional measure headed for the lowest close since Sept. 6.

Argentina, Hungary and Chile led declines among emerging-market equities at the end of last week with losses exceeding 2 percent Jan. 24. Brazil’s Ibovespa slid to its lowest level in five months, while Russian equities retreated for three straight days last week.

Traders are piling into hedges after a global rally in developed markets that has had few interruptions. The Standard & Poor’s 500 Index (SPX) jumped 30 percent in 2013, the most in 16 years, and hasn’t posted a decline of more than 10 percent in 27 months. For the MSCI All-Country World Index, the last retreat of that size was in June 2012.

Implied Volatility

Investors traded almost 600,000 puts on the iShares MSCI Emerging Markets ETF on Jan. 24, three times the average from the past 20 days, data compiled by Bloomberg show. About 150,000 calls changed hands, 45 percent more than the mean.

Implied volatility, the key gauge of options prices, rose 17 percent to 22.83 last week for the emerging-markets ETF, according to data compiled by Bloomberg on contracts expiring in three months. The measure reached the highest level since December as investors bought options to insure against further losses in underlying equities.

The biggest options trade last week on the emerging-market ETF has more than doubled in value. An investor purchased 53,500 February $39 puts on Jan. 23 for approximately $3 million, according to New York-based Trade Alert LLC. The contracts, which were bought for 57 cents each, finished trading last week at $1.36.

In the second-largest transaction, someone purchased about $2 million of 122,000 May $46 calls on Jan. 22, buying them for 16 cents each, according to Trade Alert. The bullish contracts closed at 7 cents on Jan. 24.

Open Interest

Among the 10 options with the highest ownership on the emerging-market ETF, eight were bearish, according to data compiled by Bloomberg. February $40 puts and February $39 puts had the most open interest. The iShares ETF retreated 3.9 percent to $38.24 last week.

Argentina will ease currency controls after the peso’s slide brought the rate to a level Cabinet Chief Jorge Capitanich said was acceptable.

“We’re still cautious on emerging markets,” Timothy Ghriskey, who oversees $1.5 billion as the chief investment officer at Solaris Group LLC, said by phone last week from New York. “A significant part of emerging markets keys off of China and the Chinese economy and that’s what we watch very closely. Although there have certainly been signs of improvement, there are also signs of weakness.”

Currency Selloff

Chinese factory output may shrink this month, a preliminary survey from HSBC Holdings Plc and Markit Economics indicated last week as the People’s Bank of China injected more funds to the financial system to ease a cash shortage.

A Bloomberg gauge tracking 20 emerging-market currencies fell to the lowest level since April 2009 Jan. 24. The Turkish lira weakened to a record low against the dollar and the South African rand sank to the weakest since October 2008, while Argentina’s peso depreciated to an unprecedented low.

Equities retreated worldwide amid growing concern that cuts to the Fed’s stimulus program will hurt the global economy. The S&P 500 slid 2.6 percent last week, the most since June 2012. The VIX (VIX), as the Chicago Board Options Exchange Volatility Index is known, jumped 46 percent to 18.14 for the biggest increase since 2010.

Temporary Volatility

Emerging-market stocks have underperformed advanced-nation shares during times of financial stress in the past two decades, including Latin America’s so-called Tequila Crisis in 1994 after Mexico’s peso devaluation and Russia’s default on $40 billion of debt in 1998. The MSCI Emerging Markets Index lost 54 percent in 2008, 12 percentage points more than the gauge of shares in developed nations.

The jump in volatility and retreat in stock prices are temporary because the global economy remains healthy, according to Andrew Wilkinson, the Greenwich, Connecticut-based chief market analyst at Interactive Brokers LLC.

“People do not expect this to last across time and I would expect volatility to subside in the weeks ahead,” Wilkinson said in a phone interview. “There’s a belief Argentina is in a basket of its own and I wonder how sustained the move down in stocks is going to be.”

The VIX last week closed above its futures contracts that expire over the next five months, an event known as backwardation. That suggests greater concern about the immediate future because the cost of hedging against short-term price swings is higher than what traders pay to shield themselves from volatility in the longer run, Wilkinson said.

Investor Poll

International investors are the most upbeat about the global economy than at any time in almost five years, buoyed by the U.S.-led revival of industrial nations, according to the Bloomberg Global Poll.

On the eve of the World Economic Forum’s annual meeting in Davos, Switzerland, last week, 59 percent of Bloomberg subscribers surveyed on Jan. 16 and 17 said the economic outlook was improving. That’s up from 33 percent in November and marks the most optimistic result since the poll began in July 2009.

There are about 3.32 million puts outstanding on the iShares MSCI Emerging Markets ETF, compared with 2.04 million calls, according to data compiled by Bloomberg.

The VStoxx Index, which measures the price of options to protect against Euro Stoxx 50 Index losses, rose 1.1 percent to 21.16 today after jumping 33 percent last week. The HSI Volatility Index, which tracks the cost of options on Hong Kong’s Hang Seng Index, jumped 16 percent to 17.55 today after rising 9.3 percent last week.

Short-Term Volatility

The CBOE S&P 500 Short-Term Volatility Index, tracking nine-day options on the stock gauge, soared 82 percent in the past five days, the biggest increase on record, to 20.84.

“People at the moment are more comfortable owning U.S. dollars and with a stronger U.S. economy,” Gabriel Wallach, who manages about $2.5 billion as the Boston-based chief investment officer of global emerging-market equities at BNP Paribas Investment Partners, said by phone. “They are worried about a slowdown in China still.”

To contact the reporters on this story: Nikolaj Gammeltoft in New York at ngammeltoft@bloomberg.net; Callie Bost in New York at cbost2@bloomberg.net

To contact the editor responsible for this story: Lynn Thomasson at lthomasson@bloomberg.net

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