Emerging markets are facing significant challenges after a difficult July, which is seen as a harbinger of future headwinds. Investors had high hopes for a stellar year, but these have been tested by recent events. A key factor is the volatility in artificial intelligence (AI) related stocks, particularly impacting chipmaking hubs like South Korea and Taiwan, which together comprise about 45% of MSCI’s emerging equity index. These markets are highly susceptible to swings in a handful of semiconductor stocks, with deep skepticism remaining among investors despite massive sums being pumped into AI buildout. For instance, the Kospi benchmark surged a record 18% on Friday after tumbling by nearly the same amount in the preceding three days, as chip giants SK Hynix Inc. and Samsung Electronics Co. rallied by as much as a third.
Beyond AI, broader macro pressures are compounding the difficulties. Oil prices jumped by a fifth in July as the Middle East conflict intensified, and concerns are growing about the Federal Reserve's commitment to battling inflation, potentially leading to higher US interest rates. This situation has led to an "ugly backdrop" for emerging markets, according to Roger Mark of Ninety One Asset Management, who highlights the risk to energy flows, inflation, and central bank behavior. Ed Yardeni, a veteran market strategist, downgraded his emerging-stocks stance to marketweight, citing four converging short-term headwinds: oil prices, a hawkish Fed, dollar strength, and AI fatigue.
Higher yields in developed nations typically reduce the attractiveness of emerging market debt. This spread is currently near a record low, and Morgan Stanley strategist Simon Waever warns that emerging debt will be most vulnerable if the Fed embarks on a sustained tightening cycle, especially for lower-rated sovereigns and weaker corporates. Additionally, inflation concerns are driving expectations for tighter monetary policy in emerging nations, with derivatives pricing suggesting an average of 10 basis points in rate hikes over the past month, and more than three hikes anticipated in some markets like India. The weather phenomenon El Niño, the strongest in over 75 years, poses another significant risk, as food prices are a major inflation driver for poorer nations, leading UBS strategist Manik Narain to advise clients to be "very selective" in emerging bonds. Despite a Friday rebound, where foreign investors bought $5 billion of Korean stocks, locals continued selling a record $5.8 billion worth of shares, indicating continued caution.
