The uncertainty around developing markets should be weighed against certain realities of investing
The broad rout in emerging markets following Turkey’s economic tumble has left many investors in the sector shaken. For those who have made EM stocks part of their long-term allocation, this should be no reason to let go — but it may be time to take stock of certain realities.
First, Western investors should remember that contagion is the issue, not Turkey itself. Citing a research note from Nick Colas of DataTrek Research, CNBC News noted that Turkish equities represent less than 1% of the MSCI Emerging Markets Index; that fact that the country’s equity market is down 51% in dollar terms since the start of the year should have little impact on diversified equity investors.
Second, EM equities are highly correlated, due partly to the popularity of ETFs. Mitch Goldberg, president of investment advisory firm ClientFirst Strategy, called for an end to the “synchronized global growth fantasy,” noting that synchronicity can work both ways.
“Turkey is really just a symptom of the fact that too many emerging market governments and corporations borrowed massively in dollars and now face increasing cost-of-debt service due to weakening local currency,” Goldberg told CNBC. Neena Mishra, head of ETF research at Zacks Investment Research, also noted that escalating trade tensions have been particularly painful for developing markets.
Third, EM shocks and global contagion fears aren’t anything new. The ‘90s saw three EM currency crashes — in Mexico, Thailand, and Russia — that led to broader economic fallout. There were also fears that Portugal, Italy, Ireland, Greece and Spain — the PIIGS — would sink the global markets in 2011, and they didn’t. For the long-term investor, such drops shouldn’t be so concerning.
“This is a great example of short-term thinking vs. long-term discipline,” said Douglas Boneparth, president at financial advisory firm Bone Fide Wealth. “If you are a long-term global investor and a younger investor contributing systematically to a long-term portfolio, and dollar cost averaging in, what are you so worried about?”
Fourth, EM equity returns are notoriously volatile. “The 10-year annual returns on the MSCI Emerging Markets Index through the end of 2017 were just 1.7 percent. But the 15-year returns were 12.3 percent per year,” said Ben Carlson of Ritholtz Wealth Management. “The returns from 2003–2007 were otherworldly, at 37 percent per year.
“This is an extreme example, but it shows how lumpy stock market returns can be,” he said. “Even the worst-case scenario from here isn’t all that damaging to returns, assuming you can take the long view.”
Finally, long-term investors should resist the temptation to time the market. At a time like this, it’s best to review their asset allocations; with gains from EM in recent years, they may find it’s time to sell and bring the weighting back down to its long-term target.
“Don’t throw away exposure to EM equities,” Goldberg said. “This isn’t the first or last time there will be a shock.”