Mineweb.com: A kind of contagion

The Prudent Investor says, my observations on the decline of the local market as being a contagion among emerging market classes is shared by Barry Sergeant of Mineweb.com, read his article...

A kind of contagion?
By: Barry Sergeant
Posted: '18-MAR-05 15:13' GMT © Mineweb 1997-2004

JOHANNESBURG (Mineweb.com) -- Investors have been piling out of global emerging market (GEM) stocks over the past week, and switching proceeds mainly into the dollar. The greenback is back in favour for the meantime, with record crude oil prices seen as re-igniting inflation fears, and thus an acceleration in the tightening of interest rates in the US.

So far, the carnage in emerging markets has been relatively mild, led by sell-offs originating in Latin America and developing Europe. Measured in dollar terms, the Brazilian stock market has fallen by just over 9% between its all time high on March 7, and March 16. Hungary fell 11%, again from an all-time high, between March 9 and March 17. Egyptian stocks were whacked down an average of 7.4% in the two trading days to March 17. Poland slumped 11.5% in just six trading sessions, to March 17.

The sell-off in South Africa has been relatively mild, with the market falling 5.6%, in just five trading sessions, from an all time high on March 11, to March 17. On Thursday, March 17, foreign investors were net sellers of R583-m of South African equities, according to statistics from the JSE Securities Exchange. The switch in trend from net purchases to net sellers has been evident for much of this year; for the year-to-date, foreigners have bought a net R8.5 billion worth of domestic equities, compared to R32.9 billion for the comparative year-ago period.

All told, the past week has seen the dollar-denominated Morgan Stanley Capital International (MSCI) emerging markets stock index record its longest losing streak since December 7 to December 10. The index comprises 733 companies with a combined market value of about $2.4 trillion.

This week’s sharp correction in GEM stocks sees a retreat from recent all-time highs in most markets, and may possibly signal the peak of major bull markets. However, the past week or so has also been characterised by a relatively sharp sell off in emerging market currencies. The rand, which is also classified as a commodity currency, on Monday was the biggest loser against the dollar among 16 major currencies monitored by Bloomberg. The domestic currency fell by 2.8% on the day.

Not one of the 16 currencies gained on the dollar on the day, mainly on sentiment that the Federal Reserve, the US central bank, would continue increasing interest rates. On Tuesday, the rand was again the single biggest loser against the dollar, with a slip on the day of 2.2%. The currency then recovered 0.2% against the greenback on Wednesday, before surrendering another 0.25% on Thursday, when the currency traded at five-week lows against the dollar, at R6.18.

Recent investor concerns over emerging markets can be traced to March 9, when the JP Morgan EMBI+ index, comprising emerging market bonds, mainly government debt, saw its sharpest sell off since late November last year. South African and Brazilian bonds were at the forefront of the sharp sell-off of GEM debt.

The action was triggered by frail sentiment in global markets, and more specifically by concerns that higher bond yields in the US would diminish the attractiveness of GEM debt. The widely followed JP Morgan EMBI+ emerging-market debt index had gained 26% from an eight-month low seen on May 10, 2004; over the same period the benchmark 10-year US Treasury note has lost 7%.

In examining the significant pressure experienced by GEM equities over the past week, the Bank Credit Analyst states: “We have repeatedly warned that the recent run-up in emerging market stocks has been too steep and too fast.” Some returns have been stupendous; this year alone, even after this week’s corrections, the average Egyptian stock is up by 63%; in Pakistan, the gain has been 42%.

BCA Research concludes: “A corrective phase in this asset class may now be developing.

Bottom line: A more substantial drop in prices may be needed before the correction is over.”