EMERGING MARKETS: THE WORST AND THE BEST OF 2008
Colombia-best performing emerging market in coming years.
By Polya Lesova, MarketWatch Last update: 6:59 p.m. EST Dec. 18, 2008
NEW YORK (MarketWatch) -- A year that started with great expectations for emerging markets has turned out to be a disaster.
The global financial crisis, which originated in the developed world, unleashed a storm of selling and plunged the global economy into a very severe downturn. Against this grim background, the MSCI Emerging Markets index shed 56%, as investors pulled billions of dollars out of developing economies.
As of early December on a year-to-date basis, investors removed all but $500 million of the $40.8 billion they committed in 2007 to the emerging markets funds tracked weekly by EPFR Global.
While the fundamentals of many emerging markets are better than they have ever been, 2008 made clear that decoupling is a myth, and that a sudden plunge in investors' tolerance for risk can prompt the selling of assets almost without regard to fundamentals.
Worst hit by the turmoil was Eastern Europe, where equities have tumbled 68% this year. Several countries, including Hungary and Ukraine, have sought financial aid from the International Monetary Fund.
Russia and India -- two of the four once-mighty BRIC countries -- are among the five worst-performing major global emerging markets this year. Brazil and China are also deeply in the red, down 56% and 52% respectively.Take a look at the best and the worst performers based on the MSCI Emerging Markets indexes in dollar terms:
Five worst-performing emerging markets
Russia: Equities in resource-dependent Russia have plummeted 72% this year, as the country was battered by the worst financial crisis since 1998. The sharp decline in oil prices, the global credit crunch and escalating political risk prompted investors to flee the Russian markets. Concerns over state interference in the economy, combined with Russia's war with neighboring Georgia this summer, have highlighted the political risks of investing in Russia. On top of all that, Russia now faces the risk of a large devaluation of the ruble, as the central bank's international reserves are rapidly being depleted. Considering the risks, Russia trades at a 60% discount to other emerging markets. Allan Conway, head of emerging markets at Schroders, sees a buying opportunity. "Russia is an overweight market for us at the moment," Conway said. "It has dropped down to extraordinarily cheap levels. Eighty percent of our exposure is in material related stocks, which would actually benefit from any [ruble] devaluation ...We are of the opinion that there is limited downside for oil from here."
Turkey: In Turkey, which was once the classic carry-trade country, equities have fallen 66%. Investor sentiment has been hurt by Turkey's large current account deficit, slowing economic growth, high inflationary pressures and political turmoil. The political situation stabilized after the ruling Justice and Development Party, which has Islamist roots, escaped an attempt to ban it by critics who accused it of undermining secular values. Turkey has been in talks with the International Monetary Fund about getting a new loan to help it weather the financial crisis. The performance of the Turkish market is "absolutely dependent on this IMF package," Conway said. "If the package goes through, you're going to see a very sizable bounce in the Turkish market." He cautioned, however, that it will probably be a bear market rally.
Hungary: Stocks in Budapest have fallen 65%. With a large current account deficit and a high external debt load, Hungary was hit hard by the global credit crunch and the rise in risk aversion among investors. As concerns escalated over the health of the banking system and the soaring levels of foreign-exchange loans, Hungary was forced to secure a $25 billion financial aid package from the International Monetary Fund, the European Union and the World Bank. Economic growth in Hungary could drop as much as 5% next year, according to analysts at Danske Bank. While the aid package should help stabilize the situation in the Hungarian financial sector, the government will have to tighten fiscal policy significantly, the analysts said.
India: Indian equities have fallen 65% this year as last year's rally has unraveled. In 2007, India was one of three best-performing emerging markets, but asset prices had surged to unsustainable levels. The asset bubble popped this year, as India battled to revive slowing economic growth and to contain the high current account and fiscal deficits. Also, political concerns have been rising following the terrorist attacks in Mumbai in November which escalated diplomatic tensions with neighboring Pakistan. Still, as a net oil importer, India has benefited from falling commodity prices. "Of the BRIC, the I [India] is probably the best of the four," said Jeffrey Kleintop, chief market strategist at LPL Financial. "India's outsourcing sector is benefiting from all the layoffs in the U.S. and declining commodity prices."
Indonesia: Stocks in Indonesia have tumbled 62% this year after ranking as the second-best performer in 2007 after China. The selling was so brutal this year that the Indonesia Stock Exchange had to shut down trading for several sessions in October. Economic growth is slowing down, as falling commodity prices have reduced the value of exports such as rubber and palm oil. The Indonesian rupiah has fallen sharply, hit by portfolio outflows and the weaker current account position.
Five best-performing emerging markets
Colombia: Equities in Colombia have fallen 27% this year, making it the best performer among major emerging markets. In September, Colombia eliminated capital controls on foreign portfolio investments into its equity market and scrapped a requirement that foreign direct investment stay in the country for at least two years. These measures were a strong boost to investor sentiment. Colombia, however, is one of the smaller markets in Latin America and receives only a trickle of foreign investment flows.
Israel: The MSCI Israel index is down 30% this year. It's important to note, however, that the index is very concentrated in one particular stock -- Teva Pharmaceutical Industries Ltd. (TEVA:
teva pharmaceutical inds ltd adr TEVA 44.16, +0.61, +1.4%) . In general, the Israeli stock universe is unique, because there are two primary stock markets -- Tel Aviv and Wall Street. Israel is second only to Canada in terms of the number of stocks from a foreign nation listed in the United States. In emerging Europe, the Middle East and Africa, "the cheapness of the Russian market is eye-catching," said Michael Hartnett, chief emerging markets equity strategist at Merrill Lynch, in a recent report. "But for the moment we would remain overweight Israel and Turkey until [a] trough in oil/ruble causes rotation to Russia."
Chile: The MSCI Chile index is down 20% in local currency terms and 39% in dollar terms. Chile is a prototypical defensive market that tends to do well in bear markets and to underperform in bull markets. Chile boasts macroeconomic stability and policy predictability, which has been in short supply among some of its neighbors in Latin America. While Chile is a big copper exporter and its economy is very dependent on copper prices, copper exporters are the government through state-owned company Codelco, and foreign mining companies. As a result, the stock market has little exposure to copper prices, which have fallen 56% over the last three months.
Mexico: Mexican stocks, which are down 45%, have done surprisingly well, considering that the local economy is so closely tied to the United States. Citigroup projects Mexico to be the only country in Latin America to plunge into outright recession in 2009. As a major oil exporter, Mexico is also being hurt by falling oil prices. Strategists at Merrill Lynch said in a recent report that they prefer Brazil over Mexico because of the cheaper valuations in Brazil, the larger room in Brazil for domestic currency appreciation and rate cuts, and Mexico's higher dependence on U.S. economic activity.
South Africa: Equities in Johannesburg have fallen 48% in dollar terms and 22% in local currency terms. Earlier this year, severe electricity shortages crippled the economy of South Africa, a major exporter of commodities particularly gold and platinum. Local equities have done surprisingly well considering the declines in commodity prices, the slowdown in economic growth, the high current account deficit and political uncertainty ahead of next year's general elections. South Africa's central bank cut its benchmark interest rate by 50 basis points to 11.5% in early December in an attempt to boost economic growth.
What can we expect in 2009?
So, what can investors in emerging markets expect next year?
That depends on whom you ask."I'm not overly optimistic," said Kleintop of LPL Financial. "In the fourth quarter of 2009 and in 2010 may be the bright spot for emerging markets. We're probably still six months to a year away from that."
Conway of Schroders said that while economic recovery is unlikely in 2009, emerging markets look like a "pretty good buy."
China is his favorite market and highest overweight, as valuations have come down to much more reasonable levels, he said.
"We're fairly comfortable arguing for relative outperformance of emerging markets compared to developed markets over the next couple of years," Conway said. "Their resilience in the face of the slowdown is much better than it's been in the past."
Polya Lesova is a New York-based reporter for MarketWatch.