Assumptions Shattered as Emerging Markets Get Trade Wake-Up Call

(Bloomberg) -- Emerging-market assets have risen this year based largely on two assumptions: trade talks between Washington and Beijing would gradually progress toward a deal and the U.S. Federal Reserve would stay dovish.

Two tweets from U.S. President Donald Trump on Sunday shattered the former, sending emerging markets into a tailspin, even as the latter still holds true. China’s yuan plummeted on Monday and its main stock index sank the most in more than three years, dragging assets including South Africa’s rand and Turkish stocks down with them.

The retreat suggests that weeks of positive comments from U.S. and Chinese negotiators had led investors to get complacent over the outlook for an agreement. The MSCI Emerging Markets stock index has climbed more than 10 percent this year, while a Bloomberg Barclays index of developing-nation dollar debt has advanced 6 percent.

“This is reality checking in,” said Per Hammarlund, chief emerging-market strategist at SEB AB in Stockholm. “Even if they do reach an agreement -- and I think they will -- the risk of a delay is quite significant. It’s a risk that will linger for the better part of the year and probably into next year as well. The market had pretty much ignored this.”

The rand and Turkish lira -- the two biggest losers globally on Monday -- will be among the hardest-hit currencies, according to Hammarlund, while the Russian ruble may be relatively unscathed.

Stocks could have a long way to fall. The MSCI World with China Exposure Index soared to a record high last month on optimism that a trade deal would boost Chinese demand for imports. That optimism is now looking premature.

Still, some investors saw a buying opportunity in Monday’s rout. Kathryn Rooney Vera, head of research at Bulltick LLC in Miami, recommended the MSCI EM Index, telling Bloomberg TV that an eventual trade accord would spur inflows into the asset class. She saw potential in Brazil, Mexico and China.

Following Monday’s slump, the gap between valuations based on future earnings for the S&P 500 Index and the emerging-market measure widened to the most since November.

How markets move in the coming weeks may now depend on whether there’s much bite behind Trump’s bark, according to Societe Generale SA.

“The news in the past 12 hours has thrown a monkey wrench” into the theme that a stable yuan would anchor developing-nation assets as a whole, said Jason Daw, a SocGen analyst in Singapore. “The market was basically fully priced for a positive outcome on the U.S.-China trade talks given the prior positive comments from both sides.”

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