Emerging markets, its all about the dollar

European and UK indexes continue to flounder as Brexit and Italian concerns continue to weigh on sentiment. In contrast equity markets in the US continue to hold onto gains, partly assisted by the announcement of the new NAFTA agreement between Canada, the US and Mexico. This also improved sentiment towards the hope that the Trade spat between China and the US may improve.

Having put so much effort into keeping the euro intact over the past few years, it would seem unlikely that either the Italian government or the European Union will want to undermine its prospects even if the two parties do clash. So far, the contagion into other European bond markets has been limited. Whilst the political will remains strong to hold the euro together it should hold together. As Italian yields rise this appears to have encouraged buyers of German debt as the yield on the ten-year German Bund has fallen. The gap between the yield on ten-year German Bunds is now 3%. That seems very wide for two sovereign bonds trading in the same underlying currency with the same maturity.

This months UK Markit Purchasing Manufacturing survey defied expectations with a small revision upwards from the previous month, a fall was anticipated. This data should suggest that Brexit fears may be making many headlines, however, the underlying economy in Q3 may remain resilient.

The S&P 500 has started to outperform the Russell 2000 index of smaller companies and historically this had led to something of a correction in the main index. One does get the sense that US equity markets cannot continue to buck the trend set by most parts of the rest of the world.

As one picks through the press themes often develop, oil and emerging markets being two of the latest. Emerging markets, after the fall, as to whether this is a time to invest or not? We all talk about emerging markets as one homogenous group, when of course they are not. Turkey and Argentina are going through different issues to other developing countries. As with all markets the indexes themselves may be under the cosh at times but individual companies can still grow.

Studying the MSCI Emerging Market index, it would appear, and this would be logical that trading emerging markets is just a bet on the US dollar and US interest rates. As interest rates in the US rise or the dollar strengthens this has a negative impact on emerging economies, and the performance of the index reflects that. Simple as that.

 

Posted on October 2, 2018 .