After a turbulent year that threatened to turn into a rout as US monetary conditions tightened and the trade war erupted, markets are finally showing some strength — in part because valuations have fallen so low.
While the currencies, stocks and local-currency bonds of developing economies are all heading for their worst year since 2015, they have rebounded from lows in the past few months. Emerging-market stocks slid deeper into a bear market in October as rising Fed rates pushed up the value of the dollar and the trade war intensified, hitting countries such as Indonesia and South Africa that had weaker fundamentals. Argentina and Turkey added homegrown problems to the mix, fueling contagion risks, while Mexico and Brazil navigated through presidential elections.
“Emerging-market risk premium has risen dramatically this year in many cases, laying the groundwork for potentially a much better outcome in 2019 with the caveat being the external environment can’t get worse,” said Michael Kushma, chief investment officer for global fixed income at Morgan Stanley Investment Management in New York. “EM performance this year has been disappointing, but disappointing for reasonable reasons.”
Here are some highlights and lowlights of 2018 across global emerging markets:
China-US Trade War
China offered a series of headlines that moved markets. Many revolved around trade friction with the US and the imposition of tariffs on imports by both countries. The leaders of the two nations met on the sidelines of the Group of 20 summit in Argentina on December 1 and agreed to temporarily halt the imposition of new tariffs. China’s policy makers have tried to encourage lending to cash-strapped private companies as the economy slows and the trade conflict with the US rolls on. The central bank has also cut the reserve-requirement ratio four times this year.
Historic meetings between North Korean leader Kim Jong Un and Trump as well as South Korean President Moon Jae-in have averted the risk of war, reducing what is often called the Korea discount. However, the effects of receding geopolitical risks were offset by the US-China trade war and have done little to boost South Korean assets overall. The Kospi index of shares entered a bear market along with China and the Philippines.
Mahathir Mohamad won a stunning victory in Malaysia’s election, ending the six-decade rule of former Prime Minister Najib Razak’s party. In the middle of the year, the central bank named Nor Shamsiah Mohd Yunus, who investigated the scandal-plagued state fund 1MDB, as its new governor. She replaced Muhammad Ibrahim, who resigned from the top job in June after questions were raised about the bank’s role in a deal linked to 1MDB. The state-owned investment fund has spurred criminal and regulatory investigations around the world that have engulfed global banks including Goldman Sachs.
The Indonesian rupiah’s slump to levels not seen since the Asian financial crisis in 1997-1998 triggered an unprecedented policy response both from the central bank and the government. The interest rate was raised six times this year to 6% to shield the currency that was swept up in the emerging-market rout. The government swung into action, placing curbs on imports, pushing import substitution and halting projects worth billions of dollars to cool demand for dollars. With the presidential elections due in April, investors are keenly watching if the government gets more populist or sticks to fiscal discipline to rein in the twin deficits, seen as the weak spot for Southeast Asia’s largest economy.
Investors fled amid a triple-whammy from sanctions related to the detention of a US pastor, the central bank’s reluctance to tighten policy, and broader outflows from emerging markets. Turkish President Recep Tayyip Erdogan’s conviction that higher interest rates cause inflation didn’t help to restore investor trust, either. While the central bank eventually underpinned the lira by raising borrowing costs, it was left with plenty of bruises, with the currency heading for its worst year in over a decade.
Russia Faces Sanctions
Geopolitics have weighed on what otherwise might have been a brighter year for the ruble. Sanctions related to Russia’s alleged meddling in 2016 elections, the risk of restrictions targeting ruble bonds, jitters over the poisoning of a former spy in the UK and US mid-term elections sent the currency on its third straight year of declines. That’s despite higher oil prices, what may be the first budget surplus since 2011 and one of the highest real interest rates in the developing world.
Investor euphoria over a new leader pledging to fight graft proved to be short-lived for the rand as the South African government stoked concerns with a move to expropriate land without compensation, and a return to recession increased the risk of a third junk credit rating. Delays in President Cyril Ramaphosa’s reform agenda and the ousting of his Finance Minister shortly before the annual budget presentation added to global headwinds.
Credit risk rose and foreigners were mostly net sellers of Saudi stocks amid international outcry over the murder of columnist Jamal Khashoggi at the kingdom’s consulate in Istanbul. The killing in October is the latest incident to shake confidence in policies under Crown Prince Mohammed bin Salman. Earlier in the year, the jailing of Saudi rights activists led to a rift with Canada. Meanwhile, tension with Iran is mounting, a Saudi-led war in Yemen is still raging and an embargo of neighboring Qatar has lingered since June 2017.
Populists Arise in Latin America
Latin America’s two biggest economies, Brazil and Mexico, elected populists in 2018 from opposing ends of the political spectrum, driving assets in opposite directions. While investors warmed to Brazil’s President-elect Jair Bolsonaro as he handed off fiscal responsibilities to former fund manager Paulo Guedes, they got spooked by Andres Manuel Lopez Obrador in Mexico after he canceled a $13 billion airport project. While Brazil’s benchmark stock index has soared to record highs, Mexico’s index has fallen 10% since the presidential vote on July 1.
It was the Latin American country without any political drama though that saw the biggest declines in the region and worldwide. As US interest rates rose, Argentina’s widening fiscal and current account deficits triggered a stampede out of the country’s assets that sent the peso down 50% against the dollar this year as of December 7. It took drastic action from the government and the central bank to bring the situation under control. First, the state turned to the International Monetary Fund for a $56.3bn loan. Then the central bank froze the money supply, soaking up liquidity in the market and pushing interest rates above 60%. The medicine worked, but at the cost of a second recession in three years.
The typically tranquil markets in Colombia, Peru and Chile experienced bouts of volatility as commodity prices slid and new leaders took power. In Peru, corruption scandals brought down market-friendly leader Pedro Pablo Kuczynski as well as former presidents and members of the opposition party. Out of their shadow emerged Martin Vizcarra, the ex-governor of the nation’s second-smallest state. Meanwhile, Chilean billionaire Sebastian Pinera returned to power and Colombia elected Wall Street’s preferred choice, Ivan Duque.
Venezuela: Default Drama
The world’s riskiest bond market lived up to the hype in 2018 when Venezuela defaulted on $7 billion in debt payments. In May, President Nicolas Maduro survived reelection in a vote widely seen as a charade, deflating investor optimism that a new administration could pave the way for a creditor-friendly restructuring. While the government blames the US and other “imperialist forces” for its financial woes, state-run oil company Petroleos de Venezuela has selectively forked over funds to pay one bond that’s backed by shares of its US refiner Citgo.