For long-term investors in EM, the current crisis most closely resembles conditions during the 2008-09 Global Financial Crisis and the 2013 Taper Tantrum. When we compare current outflows with those crisis points, we are somewhere near halfway done – there is still room for more outflows.
EM economies’ dependence on flows and foreign direct investment therefore leaves EM assets vulnerable on a number of different fronts. EM countries have substantial short-term financing needs that have been jeopardized as EM markets experience heavy outflows. The liquidity squeeze in DM is further pressuring the full range of assets associated with the credit markets, including EM assets.
Takeaways for investors
During this crisis, EM assets (both debt and equities) have behaved like risk assets, rising and falling more or less in tandem with equity markets across the board. We believe this pattern is likely to continue as the DM liquidity shortage continues to pressure EM.
Various developments could come together to ease the liquidity shortage in EM. A liquidity injection from DM central banks would be helpful. Fiscal stimulus could also help to support fundamentals on a near-term basis. Ultimately, however, we believe the crisis will persist until a decrease in the rate of COVID-19 infection, particularly in the United States, begins to materialize, bringing with it increased stability in DM economies. Until then, markets are unlikely to trade on fundamentals, and liquidity will remain a crucial factor in EM markets – one that deserves close attention.
Even as EM markets face substantial challenges in the current crisis, we see potential for aggressive monetary and fiscal policy moves to support underlying fundamentals and for attractive bargains to emerge in EM securities. In the meantime, we encourage investors to bear in mind the costs of liquidation when liquidity is at a premium. For long term investors, we believe that EM assets will continue to be an important source of diversification and growth.