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Calm Broken in Markets Amid Concern of Emerging Contagion

By Whitney Kisling, Eleni Himaras and Weiyi Lim
January 30, 2014 4:13 PM EST 13 Comments
Turkey Contagion Concerns
Turkey Contagion Concerns

Declines that erased $1.7 trillion from global stocks as currencies from Turkey to Argentina slid are proving a Wall Street maxim, according to Brian Barish of Cambiar Investors LLC: selling can start anywhere.

“You’re never fully prepared for something like this,” Barish, president of Denver-based Cambiar, which manages $9 billion, said in a phone interview. “You say to yourself, ‘I know the froth is picking up, I know this is starting to get a little out of hand, this is going to get ugly when the hammer comes down.’ You know all of that, but you just don’t know what is going to get sold and why and by who.”

From Thailand and Russia in the late 1990s to Portugal and Greece three years ago and Turkey and Argentina today, crises in emerging markets are as hard to predict as they are to contain. Now they’re threatening a run of gains that has gone virtually uninterrupted in the developed countries for more than a year as investors adjust to a world where neither China nor the U.S. are likely to ride to the rescue.

The MSCI All-Country World Index, which came within 5 percent of an all-time high on New Year’s Eve, has dropped 4 percent since Jan. 22, the worst losses for worldwide equity markets in six months. Turkey’s attempt to stem declines in the lira backfired as a doubling of official interest rates led to even more selling. Stocks tumbled anew yesterday as the Federal Reserve said it would curtail its bond-buying program in the second month of reduced stimulus.

Obscure Causes

“The reasons are always a little bit unexpected,” said Khiem Do, head of Asian multi-asset strategy with Baring Asset Management in Hong Kong. Though the causes are obscure, the outcome was predictable, he said. “The correction is long overdue.”

The Standard & Poor’s 500 Index (SPX) tracking the biggest American companies fell 1 percent yesterday, bringing its decline since the Jan. 15 record to 4 percent. The Turkish currency depreciated as much as 2.4 percent after strengthening about 4 percent during the day. South Africa’s rand sank more than 2 percent even as the central bank unexpectedly raised rates. Gold increased 0.8 percent and copper fell.

Stocks Retreat

The S&P 500 rose 1.1 percent to 1,794.19 at 4 p.m. New York time today, after the gauge dropped to the lowest level since Nov. 12. The MSCI Asia Pacific Index lost 1.5 percent and the Stoxx Europe 600 Index climbed 0.3 percent. India’s rupee weakened 0.3 percent versus the dollar and Indonesia’s rupiah slid 0.4 percent.

Emerging-market stocks have had the worst start to a year since 2008 as currencies from Turkey to South Korea tumbled. Sentiment toward the markets had started to sour last year after the Fed signaled it would scale back stimulus and as China’s economic growth showed signs of slowing. The MSCI Emerging Markets Index has slipped 11 percent from an October peak. A Bloomberg gauge tracking 20 emerging-market currencies has fallen to the lowest level since April 2009.

“It definitely caught people off guard,” Kevin Chessen, head of international trading and managing director at BTIG-Baypoint Trading LLC, said by telephone. “People came into January quite bullish. Then all of a sudden you started to see a few chinks in the armor, and it caused people to scramble. People also don’t have enough protection on like they’ve had in the past. It may be why the selloff got exacerbated.”

Constant Watch

Turkish central bank Governor Erdem Basci is fighting to arrest a currency run after a corruption scandal that broke last month ensnared several cabinet members. The political fallout coincided with an outflow of money from emerging economies including Brazil.

Argentina allowed the peso to plunge 15 percent after the central bank began scaling back interventions in the foreign-exchange market last week. Global stocks declined 3.3 percent since Jan. 23, when a factory index in China fell short of economist projections.

“The environment is changing so quickly and just to make sense of so many moving parts is extremely challenging,” Benoit Anne, London-based head of emerging-markets strategy at Societe Generale SA, said in a phone interview from New York. Anne said he woke up at 2 a.m. on Jan. 29 for Turkey’s central bank decision and was awake again at 4 a.m. to monitor the market before arriving for work at 7 a.m. for a morning meeting.

“It’s almost around the clock,” he said. “It’s extremely stressful.”

Currencies Fall

All but seven of 24 developing-nation currencies fell yesterday, with Russia’s ruble and Mexico’s peso losing more than 1 percent against the dollar. The South Africa Reserve Bank unexpectedly raised the repurchase rate to 5.5 percent from 5 percent, following Turkey’s decision to boost borrowing costs after a late-night emergency meeting.

“If you look at the things that have kicked off over the last two weeks in terms of currency, they are kind of long overdue,” said Gary Dugan, who helps oversee about $53 billion as the Singapore-based chief investment officer for Asia and the Middle East at Royal Bank of Scotland Group Plc’s wealth management unit. “All of these things are well known, but it reached a crescendo that broke the back of the market.”

Speculation that developed market stocks were due for a retreat has built for months, including forecasts this month from Blackstone Group LP’s Byron Wien and Nuveen Investment Inc.’s Bob Doll Jr., who both called for a 10 percent drop. The S&P 500 hasn’t lost 5 percent since June 2013. For the MSCI All-Country index, the broadest gauge of global equities, the last retreat of 10 percent was in June 2012.

Finding Opportunities

Global stocks had surged since mid-2012, with U.S. equities capping a fifth year in a bull market, as the Fed implemented three rounds of quantitative easing and earnings nearly doubled. Ignoring turmoil in emerging markets, the Fed said yesterday it will trim its monthly bond buying by an additional $10 billion, sticking to its plan for a gradual withdrawal from departing Chairman Ben S. Bernanke’s unprecedented easing policy.

The emerging-markets selloff has done little to dent the $10 trillion of stock value that was created worldwide in 2013, when the S&P 500 advanced 30 percent and Japan’s Topix Index (TPX) climbed 51 percent.

“I like days like this,” Carsten Hilck, who oversees about 5 billion euros ($6.8 billion) as senior fund manager at Union Investment Privatfonds GmbH in Frankfurt, said in an interview. “Risk and reward goes together in markets like this. Turbulence makes prices move so I can react.”

1998 Similarities

This year’s drop in global equities is half as large as the worst retreat of 2013, when the MSCI gauge fell 8.8 percent from May 21 through June 24 after Bernanke raised the possibility in Congress of reducing stimulus. It slid 14 percent between March and June 2012 as Europe struggled to extinguish its sovereign debt crisis in Greece and Portugal.

Declines will prove temporary, much as they did in 1998, according to Mark Matthews, the Singapore-based head of Asia research for Bank Julius Baer & Co. Like then, the latest selloff comes after a five-year advance lifted valuations above historical averages. The S&P 500 traded as high as 17.4 times annual profit in December, the most expensive level in almost four years, data compiled by Bloomberg show. In 1998, stocks rebounded from a 19 percent drop that came as currency turmoil in Asia and Russia spread to developed markets.

The most vulnerable emerging markets “have already reached a bottom in terms of their ‘badness,’” Matthews said. “Even if they do continue to see economic slowdown, I cannot believe it would be enough to derail the strong U.S. recovery.”

Market Breadth

The global economy will grow 3.7 percent this year, up from an October estimate of 3.6 percent, the International Monetary Fund said in revisions to its World Economic Outlook released Jan. 21, citing accelerating expansions in the U.S. and U.K. Economies of Japan, Europe and the U.S. are forecast to expand together for the first time since 2010, according to data compiled by Bloomberg.

A total of 460 stocks in the S&P 500 ended higher in 2013, the most since at least 1990, according to data compiled by Bloomberg. While breadth of that nature has been a bullish stock-market indicator in the past, the turmoil in emerging markets this year is leading investors away from equities, according to Jawaid Afsar, a trader at Securequity Ltd. in Sheffield, England.

“Last year, you could’ve picked any stock at any time and you didn’t need protection because the markets kept going higher and higher,” Afsar said by telephone. “Suddenly, emerging markets have tumbled across the board, currencies are getting hit hard, so people are running for cover. It’s come out of the blue.”

Treasury Haven

Stress in emerging markets has made a winner out of two of last year’s least-loved assets. Treasuries rose yesterday, pushing 10-year note yields down to the lowest level in two months. Gold, which posted its worst annual return since 1981 last year, has climbed more than 5 percent in January.

Shifts among asset classes and the global declines in 2014 have led to a surge in volatility. The Chicago Board Options Exchange’s Volatility Index (VIX), known as the VIX, reached 18.14 this month, the highest level since October, and average daily moves in the S&P 500 rose to 0.55 percent, compared with 0.44 percent in December, data compiled by Bloomberg show.

“My phone hasn’t stopped ringing in the past few days, and I met with about half of my clients, as some of them have direct exposure to emerging-market currencies,” Lorne Baring, who manages about $500 million as managing director of B Capital in Geneva, said in a telephone interview, adding the firm reduced emerging-market exposure prior to the selloff. “They want to know my views on whether the situation is going to get worse, and I tell them yes, it will.”

To contact the reporters on this story: Whitney Kisling in New York at wkisling@bloomberg.net; Eleni Himaras in Hong Kong at ehimaras@bloomberg.net; Weiyi Lim in Singapore at wlim26@bloomberg.net

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

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