Emerging markets may be vulnerable today to the same sort of indiscriminate selling that from the late 1990s.
“The wildfire engulfing the developing world is starting to look very like the currency runs of the past, such as the Asian, Russian and Latin American collapses that began in 1997.
“We’ve seen this movie before,” said Dominic Rossi, Global CIO for equities at fund manager Fidelity. “One emerging country after another gets left stranded on the shore as the tide goes out. The weakest ones first, Argentina and Turkey, soon to be followed by Brazil, Russia and others.”
Emerging markets have been inflated in recent years by huge amounts of cheap cash created by the U.S. Federal Reserve… With the Fed scaling back the program, that flow is reversing and the currencies of countries with the biggest economic and political problems are diving.
There are three main reasons why these markets could again suffer the capital flight that plagued them during the 1990s.
First is the scale of money that has moved to developing markets over the past decade and now dwarfs the sums which fled in panic 15 years ago.
Secondly, lending into emerging markets has increasingly been through bond markets, rather than in the direct bank loans that dominated previously and which involved longer-term relationships between banks and the firms and countries.
Thirdly, the emergence of index-tracking Exchange Traded Funds (ETFs) over the past decade has arguably increased the indiscriminate nature of emerging market inflows, leaving them ever more vulnerable to lockstep withdrawals.
So for all the transformation of emerging economies, their higher credit ratings, superior balance sheets and infrastructure, investors still tend to lump developing countries together when markets sell off, Goldman Sachs CEO Lloyd Blankfein told Reuters Television.
Blankfein said people who carefully weighed one investment against another when entering a market, were much less discriminating when departing in haste.
“When times are good emerging markets are like a credit business, name by name,” he said. “When things get bad, forget the names, it’s a macro event. Forget the differences, they are all emerging markets.”
Emerging markets have attracted about $7 trillion since 2005 through a mix of direct investment in manufacturing and services, mergers and acquisitions, and investment in stocks and bonds, the Institute for International Finance estimates.
The result, many say, is a recipe for fund redemptions snowballing when returns fall below a certain level.
“We are in full-blown financial contagion mode. There is no point spending too much time trying to pick and choose when faced with a severe market crisis like the one we are witnessing,” said Benoit Anne, head of emerging markets strategy at Societe Generale.
“Right now, sell everything.”