If you’re looking for a good end-of-summer book to read, try Red Notice, the story of Bill Browder, a hedge fund manager who got rich off investing in Russia in the 1990s and 2000s. While the book details Browder’s incredible run-ins with the Russian government and police, and his role in getting the Magnitsky Act passed, the investing parts are the most fascinating.
There’s one section in particular that stood out as I read the book. In 1997, as the Asian currency crisis began, Browder’s investors started getting nervous. He reassured them that Russia and Asia had nothing to do with each other and that their Russian investments would be safe. Not long after, the Russian stock market tanked and Browder’s fund fell by 90%. He learned an important lesson: That when one emerging market suffers they all do.
While many markets have matured since then, that idea still holds true—and we’re seeing it play out today. Turkey’s Borsa İstanbul index has fallen by 25% year-to-date and about 10% over the last week, while the country’s lira has fallen by about 18% over the last month. Many other emerging markets have followed suit, with indexes in Argentina, China and Mexico all lower over the last several days.
Turkey’s gloomy economic picture
With Turkey, there are several reasons why it’s struggling, but a big one is that its inflation rate is running at 15% and its central bank failed to increase interest rates above its current 17.75% (yes, that’s still high) at its last meeting. President Recep Tayyip Erdogan has called interest rates “the mother of all evils,” which isn’t giving the market confidence that it’ll be able to get inflation under control. It doesn’t help that America doubled Turkey’s steel and aluminum tariffs to 50% and 20%, respectively, to punish it for holding a U.S. pastor in prison.
Some of the fund managers I’ve spoken to this week think that this issue will be isolated to Turkey, but as we’ve seen time and time again, when one emerging market stock is in the headlines they all are. Despite Turkish stocks representing less than 1% of the MSCI Emerging Market Index, that index is down 15% over the last six months and nearly 6% since August 9. While poor quarterly numbers, announced on Wednesday, for Chinese tech behemoth Tencent contributed to the decline, if Turkey remains in the spotlight, expect EM’s woes to continue.
One big risk
Even though we’ve come a long way from the Asian currency crisis, emerging markets continue to be seen as one giant risk asset. There is some cause for concern that the Turkey issue could spread—several European banks have stakes in Turkish banks, and those investments could be threatened if its economy collapses. But, more generally, when people feel bullish they buy into these markets for what they hope will be outsized returns (developing nations are still growing faster than developed ones) and then sell out whenever some issue arises. With that kind of volatility, some investors are wondering if there’s a point of investing in EM at all.
A note from DataTrek Research said that emerging markets are more of a one- to two-year trade than a long-term investment. The play only works when the market is recovering from a crisis, it says. It points out that only two times since 2009 has the market gone up in any significant way. It doubled between 2009 and 2011 and then rose 60% between January 2016 and 2018. “Everything else was just treading water,” said the authors of the note.
Long-term gains, short-term pains
So, should you invest in emerging markets? If you have a long-term view, and can stomach big ups and downs, then it can make sense to own it as part of a diversified portfolio. Over the last 20 years the MSCI Emerging Market Index is up 149%, not too far off the S&P 500’s 190% and these countries are still growing up. Over the last decade though, it’s only up about 7%, while the S&P 500 is up 122%. For those who want to own some emerging markets, a broad-based ETF makes sense as country ETFs or funds can be even more volatile than the overall index.
On a shorter-term basis, many experts are saying to hold off for now, especially with the impact of tariffs on China and other markets still unclear. Datatrek says “it’s going to be a slow grind, at best, for emerging market equities,” while Capital Economics, in its own note, pointed out that China’s economic data isn’t looking so hot. “China’s economy will continue to slow over the rest of this year,” said the firm. “This is a key reason why we think that EM assets will generally continue to struggle, regardless of what happens in Turkey.”
According to the numbers, you may want to wait to dive into emerging markets until stocks drop in a more significant way. Otherwise, you’ll find out like Browder that when one market runs into trouble, others will follow.
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