The U.S. stock market is not doing well right now, but emerging markets are doing even worse. Combine the fact that emerging markets are, by definition, more volatile than developed markets with the fact that they have begun to correlate more closely with developed markets, and this isn't necessarily surprising.
But figuring out exactly why those markets are suffering so much more than developed markets can be a bit difficult, as is figuring out what to do as an investor. While many are fleeing emerging markets, others are seeing opportunity.
Basically, the credit crisis has spread to emerging markets, and it's affecting them in a number of ways. As mind-boggling as the idea is, yes, the subprime loan disaster that started with residential mortgages in the U.S. is having reverberations that are threatening to destabilize entire economies in the developing world. Talk about a butterfly effect ...
In its most basic terms, you could probably say that emerging markets have been hit by a double whammy. For one thing, the U.S.-originated credit crisis has rocked developed markets, making loans expensive proposition. For another, with the developed markets in turmoil, emerging markets are seeing their customer bases for raw materials and manufactured products dry up as demand falls. Oh, and let's not forget the falling currencies.
An article from BusinessWeek describes how the prevalence of foreign-denominated debt is causing problems in countries that have seen their own currencies fall in value. Meanwhile, Dow Jones Newswires reported on how it's getting more expensive to insure sovereign debt from emerging markets against default, and The Wall Street Journal (subscription) features an article in the same vein about how emerging markets governments are seeing their borrowing costs rise rapidly. Canada's Financial Post detailed how such countries are burning through their currency reserves and may be forced to seek financial assistance from the International Monetary Fund.
And speaking of the IMF, the Financial Times (subscription) also features an editorial written by the senior vice chairman of Citigroup and head of Citibank and Citicorp Holdings, William Rhodes, calling for the IMF to shore up vulnerable markets that have made efforts at financial reforms, but have been dragged down recently by forces beyond their control.
Despite this, there are still signs of continuing optimism to be found. A Fortune article posted on the CNNMoney site says that emerging markets are cheap, post-plunge, and suggests a number of ETFs and mutual funds that offer access to them. Institutional investors in northern Europe would seem to agree; according to a recent FT article (subscription), three-quarters of them are looking to increase their emerging markets exposure over the next three years.
Those articles, however, are at odds with recent research published on the ResourceInvestor.com Web site by Carmen and Vincent Reinhart—a professor of Economics at the University of Maryland and a resident scholar with the American Enterprise Institute, respectively—that suggests emerging markets that have enjoyed "bonanza years" in terms of capital flows may be seeing an abrupt reversal followed by some grim times.
With the MSCI Emerging Markets Index down nearly 60% year-to-date, it seems like the bonanza is definitely over, but the question is whether it will restart itself anytime soon—or whether investor interest will turn to another tier on the economic development spectrum. While the MSCI (Developed) World Index is down about 43%, year-to-date, the MSCI Frontier Markets Index, presumably comprising markets that are more "decoupled" from developed markets, is down roughly 39%.