China Drives Emerging Market Selloff and Flight to Safety

in Market Commentary by

Market Digest – Week Ending 1/24

Stocks were up modestly for the first two days following Martin Luther King, Jr. Day, with gold and Treasuries modestly down. These trends sharply reversed following China’s disappointing manufacturing report on Thursday, causing investors to flee all risky assets. The S&P 500 ended the week down -2.6%, with emerging market stocks down -4.7% on Thursday and Friday alone. Investors found safe havens in gold and developed market bonds, which both ended the week in positive territory.

Weekly Returns:

S&P 500: 1,790 (-2.6%)
FTSE All-World ex-US: (-3.1%)
US 10 Year Treasury Yield: 2.72% (-0.10%)
Gold: $1,269 (+1.3%)
USD/EUR: $1.368 (+1.1%)

Major Events:   

  • Monday – Martin Luther King, Jr. Day.
  • Tuesday – Mohamed El-Erian announced he is stepping down as CEO of Pimco, leaving Bill Gross as the firm’s sole chief investment officer.
  • Wednesday – EBay unveiled a $5 billion share buyback program and said it rejected a proposal from Carl Icahn to spin off its PayPal division.
  • Thursday – China’s preliminary manufacturing Purchasing Managers’ Index came in weaker than expected, sparking a sell-off in emerging market and global stocks.
  • Friday – Thursday’s global sell-off continued as investors fled all risky assets.

Our Take:

Emerging market stocks sold off sharply over the past couple of days. Two major drivers are at play: China and fears of rising interest rates. On Thursday, the preliminary manufacturing Purchasing Managers’ Index for China came in below expectations, indicating contraction. Investors were hoping for an improvement after its economy slowed in the fourth quarter of last year. The weaker than expected reading, coupled with ongoing fears of US Fed tapering, sparked a sell-off in both emerging market stocks and certain EM currencies. The downward trend continued on Friday with investors fleeing virtually all risky assets, including developed markets stocks.

There’s no denying a slowdown in China would adversely impact EM growth, but this has been on the radar for some time now. The country is in the process of transitioning from an export based economy to one of domestic consumption. As such, there will naturally be bumps in the road. It is too early to claim Thursday’s weaker than expected manufacturing reading as indication of a full blown slowdown.

There is also a fear that emerging market countries will not be able to support growth should the US Federal Reserve unwind stimulus measures and drive up interest rates. While this could certainly make conditions more challenging, we don’t believe it warrants full blown panic selling. EM countries have significantly improved their balance sheets in recent years. According to the IMF, government debt has fallen from 48.7% of GDP in 2000 to 34.7% in 2013. There may be spots of weakness, but in aggregate the region is much better prepared to handle currency and growth volatility than in the past. Moreover, improving economic conditions in the US and Europe should help bolster demand for EM exports over time.

This is a kneejerk reaction, and we do not believe it is time to abandon EM stocks altogether. They continue to play an important role in well-diversified investment portfolios, and should benefit over the long-term from faster economic growth relative to developed markets.

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Brendan Erne, CFA
Brendan Erne serves as the Portfolio Management Team Leader with Personal Capital Advisors. He has over 15 years of industry experience, spanning almost all levels of the investment process, including several years at Fisher Investments as an equity analyst covering the Technology and Telecommunications sectors. He also co-managed a large cap growth portfolio and co-authored Fisher Investments on Technology, published by John Wiley & Sons. Brendan is a CFA charterholder.

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