Opinion  

Is there potential for emerging market contagion?

Tanvi Kandlur

Tanvi Kandlur

So far, 2018 been a tough year for emerging market equities owing to various economic, political and market developments including Russian sanctions, US dollar strengthening, the US-China trade war tensions, and Brazilian truckers strike, among others. 

The dispute between the US and Turkey began following Turkey’s refusal to release an American pastor who has been detained for nearly two years.

The Turkish lira and stock market took a bigger hit when President Donald Trump's administration approved the doubling of tariffs to 20 per cent and 50 per cent on Turkish steel and aluminium respectively. Turkey supplies only 1 per cent of the US's imported aluminium and less than 4 per cent of its steel in 2017.

However, the market is pricing in concerns about Turkey’s high inflation and current account deficit, as well as foreign currency debt and the direction of economic policy under President Recep Tayyip Erdogan.

More recently, the Trump administration announced a 10 per cent tariff on $200bn of Chinese imports, and threatened to increase the rate to 25 per cent in 2019 if no deal was reached to ease the tension between the two countries. China retaliated by imposing tariffs of up to 10 per cent on $60bn of US imports.

Global stock markets sold off in response to the trade conflicts characterised by a risk-off sentiment, sending emerging markets lower. However, there is the risk of contagion, much of which has already been felt through most emerging market currencies.

The chart below shows the year-to-date performance of the FE Invest Approved List funds. Some of the more underperforming funds have been facing issues.

Source: FE Analytics

Having met with Edward Lam, portfolio manager of Somerset EM Dividend Growth, he stressed that the macroeconomic case for Turkey has changed, which has forced him to reassess his holding in the country.

Coming into 2018, the fund’s relative exposure to Turkey stood at around 5 per cent, but he has been progressively selling this exposure down which proved to be a good move.

However, he is maintaining his position in one company on a stock-specific basis.

A larger chunk of the fund’s underperformance is coming from the fund’s largest holding in SK Hynix, a South Korean semi-conductor company. The stock fell alongside other chipmakers after Morgan Stanley warned that elevated inventory levels and stretched lead times leave "no margin for error", cutting its outlook for the sector from ‘in-line’ to ‘cautious’.

It also pointed to a slowdown in global manufacturing in 2018, suggesting more caution around trade tensions. 

James Donald, portfolio manager of Lazard Emerging Markets pointed to the lack of central bank independence, along with President Erdogan’s unwillingness to raise short-term rates, which has recently strained the Turkish lira.

He added to his Turkish exposure on weakness in the second quarter to one company that benefits from a depreciating lira, as close to half of its revenue is derived from outside of Turkey.