Emerging Markets

Investors in emerging-market (EM) stocks have taken a big hit as Turkey’s crisis has escalated. But a closer look inside the EM benchmark suggests that the entire developing world isn’t broken.

The MSCI Emerging Markets Index dropped by 7.2% this year through August 31. Turkey’s currency crisis, followed by the Argentinian peso crash, has stoked fears of contagion. But our research shows that 80% of the index is in countries with a positive current account balance when foreign direct investment (FDI) is included. We add FDI to the calculation since these investments tend to be sticky and aren’t usually withdrawn rapidly, even when a country is in trouble.

Countries also react differently to EM turmoil. During 15 EM sell-offs over the last decade, some countries, like Malaysia and the Philippines, fell much less than the benchmark did. Others—like Brazil and Russia—fell more than the index, with a downside capture exceeding 100%.

So how should equity investors react to macroeconomic fears? We think macro analysis is an important risk factor in emerging markets because currency sell-offs typically trigger a simultaneous downturn in all asset classes. As a result, even strong stocks will get hammered in a crisis.

On the other hand, a positive macroeconomic outlook shouldn’t guide portfolio positions. Rather, look for companies in stable regions that have strong businesses, healthy balance sheets and a robust business outlook to support equity returns.

For example, Thailand and Taiwan have solid fundamentals and a stable local banking industry. Convenience store operators in both countries are resilient to e-commerce. India’s macroeconomic profile is reasonably balanced, and the country boasts a strong IT service industry.

When macro fears dominate market sentiment, stockpicking still matters. EM investors should always look for profitable companies that are deploying capital well. Picking long-term winners that can weather the current storm could be very rewarding when the environment improves. These days, many companies trade at attractive valuations and as a result offer more return potential if emerging markets rebound from the drag of Turkey’s woes.