Selling Returns to Emerging Markets as China Rally Fades

An equity rally led by China’s stimulus plans proved fleeting as emerging markets were being whipsawed on Tuesday by investor nervousness over the US economy and the dollar’s resurgence.

(Bloomberg) — An equity rally led by China’s stimulus plans proved fleeting as emerging markets were being whipsawed on Tuesday by investor nervousness over the US economy and the dollar’s resurgence.

A benchmark subindex for stocks in Latin America erased its gains after a strong start, and so did its counterpart for the emerging Europe, Middle East Africa region. That offered a contrast to the Asian trading day, when optimism China will step up measures to support the economy and markets had sparked a tech-stock rally in Hong Kong, firmer iron ore prices in Singapore and a stronger South African rand. 

Emerging-market equities are heading for the worst August since 2015, the year traders remember for an unexpected devaluation of the yuan that sparked global panic. This time, China is using some of the tricks from the same playbook it used then: authorities asked mutual funds not to become net sellers of stocks after a selloff erased $1 trillion from shareholder wealth. Such moves didn’t help eight years ago and some traders speculate they won’t now.

Read more: China Pledges to Speed Up Fiscal Spending to Boost Economy

“We see an increasing risk of the Chinese equity market running into a prolonged stagnation and recommend that global investors calibrate their China position as we expect flattish equity returns,” said Nenad Dinic, a strategist at Bank Julius Baer in Zurich. “Emerging-market equities will struggle to outperform developed markets if the current headwinds in China persist.”

China’s largest banks are preparing to cut interest rates on existing mortgages and deposits, as they sought to shore up the country’s growth and arrest a property slump. Hopes for more such measures —with some betting on a big-bang stimulus plan — are helping investors to take advantage of cheaper valuations that resulted from this month’s selloff. Emerging-market stocks trade at a forward price-earnings ratio of 11.8 times, below their five-year average of 12.3. The yield sovereign dollar bonds reached the highest since November on Aug. 21 and has been easing since. 

Read more: China Media Ask Stock Investors for Patience; Expect 4Q RRR Cut

Meanwhile, China’s fundamentals aren’t showing any sign of improvement. Economists surveyed by Bloomberg reduced their forecast for growth this year in the world’s second-biggest economy, to 5.1% from 5.2% seen earlier. Troubled real estate firm Country Garden Holdings Co. sought a longer grace period to pay a maturing yuan bond in an attempt to avoid a default. That follows the Evergrande group’s decision this week to postpone key votes on its offshore-debt restructuring plan.

Read more: Country Garden Seeks to Add Grace Period for Maturing Yuan Bond

Turkey came under the spotlight after its bigger-than-expected rate hike last week. While the move has brought mixed fortunes for the lira, the country’s dollar bonds posted some of the best gains among emerging-market peers on Tuesday. The country’s credit default swaps eased to 378 basis points, near a two-year low. London traders coming back from Monday’s holiday may bring more volumes to the assets.

Read more: China ETF Sees Continuous Outflows (Video)

South Africa, a bellwether for emerging-market sentiment, witnessed positive spillovers from China’s stimulus plans. The rand advanced as much as 1%, while its dollar bonds also figured among the outperformers on the Bloomberg Emerging Markets Sovereign Total Return Index.

Deutsche Bank strategists now see the most value in South Africa’s longer-term bonds on the back of a steepening of the yield curve. A fragile environment for global bonds has been adding to investor concern about South Africa’s fiscal outlook. The strategists say bonds have overpriced the country’s risk.

Hungary’s forint advanced as the nation’s central bank reduced its overnight interest rate by a full percentage point as policymakers combat a recession. In Mexico, the peso erased its advance, partly driven by a jump in the dollar and partly by data showing economic activity was slower than expected.

Read more: Peso Reverses Gains After Weak Local Activity Data: Inside Mexico


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