Emerging Markets and the Black Swan

Turkey Swan pic

By David Nelson, CFA

With good reason to celebrate investors headed to the beaches Friday on the heels of another strong month for U.S. markets. The lack of any meaningful reaction following a missed deadline for NAFTA and a full court press from the administration threatening additional tariffs on $200 Billion in Chinese imports shows investors are either;

  1. convinced that ultimately there will be a resolution or
  2. the fallout from tariffs will be less than the bears believe

There’s been no shortage of good economic news to help return U.S. markets to their highs. A 4.2% GDP print along with a Consumer Confidence hitting the highest levels in 18 years go a long way toward boosting investor confidence.

Not so, for emerging markets as the charts below indicate. EM investors have had to take on one disaster after another. A currency crisis in both Turkey and Argentina shows a mass exodus of capital from both countries into safe-haven assets.

Turkish Lira & Argentine Peso
Turkish Lira & Argentine Peso

On a relative chart pitting the S&P 500 vs the MSCI Emerging Markets Index the fork in the road coincides with a rising dollar which weighs on dollar denominated debt.

S&P 500 vs MSCI Emerging Markets Index

If there’s a Black Swan on the horizon this is where it lives. Plummeting currencies along with credit default swap spreads exploding higher is confirmation the picture outside the U.S. is less than ideal.  Yes, the political risks here are rising and of course we’re coming up on a mid-term election perhaps one of the most controversial in years. However, the bigger risks are likely not in our own back yard.


Whether it’s Turkey, Argentina, Russia or Poland financial conditions are tightening. In a note this week Goldman points out that in aggregate PMI’s have decreased indicating a sharp slowdown in activity.

China is of course tougher to judge given the opaque lens into their economy. However, the recent government decisions to have banks ease lending conditions indicates an economy under pressure.

All of the above takes place against a backdrop of an asset glass that has offered little in returns for more than a decade despite high volatility coupled with false promises of growth. We’re consistently being told EM is the smart choice because it’s cheaper than the U.S. Cheap for a reason!

iShares MSCI Emerging Markets ETF (EEM) 2006-Present
EEM 11 years

Back here in the U.S. we’re having no trouble finding companies with healthy balance sheets, earnings growth and pricing power. However, the overriding message is that outside the United States our customers are struggling. It’s only a matter of time before that starts to hit the top and bottom line of U.S. multinationals.

The above isn’t a prediction but an observation and an important message that we should be on heightened alert for any material slowdown off shore.

By definition; a Black Swan event is “unpredictable or unforeseen.” Maybe the fact that I’ve brought it up for discussion will help keep it at bay.