The Consequences of the Global Liquidity Crisis for Emerging Markets Investors
The short – but extremely eventful – history of the COVID-19 crisis began in emerging markets (EM). As the crisis expanded to encompass the globe, it has morphed from an exogenous shock affecting mostly EM, to an oil shock impacting risk assets including EM, to its current manifestation: a liquidity shock to global markets, resulting in substantial outflows and plunging prices in EM. Asian currencies and Asian equity and debt markets have collapsed,1 culminating in the closure of financial markets in the Philippines on March 17.
It will be some time before EM investors are able to align their decision making to fundamentals2. At this point, liquidity is the key factor to watch. To that end, this commentary will focus on the impact of the current liquidity shock on EM debt and equity markets.
Dependence on Liquidity and Flows
EM markets have seen a regime shift to what seem like end-of-cycle conditions in which liquidity, positioning, funding needs and fears of forced selling are front and center. Fund flows are an immediate area of focus. Many EM economies are running large current account deficits (see Figure 1) that they have compensated for through flows in capital accounts and foreign direct investment (FDI). FDI has been stable or declining in most EM countries, although lower oil prices have supported EM trade balances overall. Based on current account balances and FDI, South Africa, Chile, Colombia, and Indonesia are most in need of flows (see Figure 2).
Of course, the present inertia does not mean that emerging markets are free of fundamental challenges. Emerging markets’ potential for GDP and earnings growth are a serious concern. In addition, much-needed structural reforms are likely to be put on hold as EM countries focus their attention on combatting the outbreak.
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.
1For example, as a recent report by UBS points out, recent outflows in Asian equity markets have neutralized almost all 2019 inflows into the region, and have at this point exceeded the full-year outflows from the 2011 and 2015 EM equity sellofs, combined. (Source: EM: How Much Value Has Been Created in the Selloff? [UBS, 17 March 2020]). 2The swift course of events in this crisis limits the ability to forecast based on fundamentals. We see an example of this in the analyst community. As of February 29, 2020, over 50% of sell-side analyst estimates had not changed over the previous two months. Nearly 20% of the revisions anticipated improvement in earnings-per-share. (Source: State Street Global Advisors and Factset.)
Past performance is not a reliable indicator of future performance. Index returns are unmanaged and do not reflect the deduction of any fees or expenses.
Diversification does not ensure a profit or guarantee against loss.
Investing involves risk including the risk of loss of principal. The views expressed in this material are the views of Gaurav Mallik through the period ended March 24, 2020 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected.
The targets and estimates are based on certain assumptions and there is no guarantee that the estimates will be achieved.
All information is from State Street Global Advisors unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
The information provided does not constitute investment advice and it should not be relied on as such. It does not take into account any investor's particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
The trademarks and service marks referenced herein are the property of their respective owners. Third party data providers make no warranties or representations of any kind relating to the accuracy, completeness or timeliness of the data and have no liability for damages of any kind relating to the use of such data.
The information contained in this communication is not a research recommendation or ‘investment research’ and is classified as a ‘Marketing Communication’ in accordance with the Markets in Financial Instruments Directive (2014/65/EU) or applicable Swiss regulation. This means that this marketing communication (a) has not been prepared in accordance with legal requirements designed to promote the independence of investment research (b) is not subject to any prohibition on dealing ahead of the dissemination of investment research.
The whole or any part of this work may not be reproduced, copied or transmitted or any of its contents disclosed to third parties without SSGA’s express written consent.
ETFs trade like stocks, are subject to investment risk, fluctuate in market value and may trade at prices above or below the ETFs net asset value. Brokerage commissions and ETF expenses will reduce returns. Changes in exchange rates may have an adverse effect on the value, price or income of an investment. Further there is no guarantee that an ETF will achieve its investment objective. SSGA SPDR ETFS MAY NOT BE AVAILABLE OR SUITABLE FOR YOU. THE VIEWS EXPRESSED/INFORMATION IN THIS SITE DOES NOT CONSTITUTE INVESTMENT ADVICE, FINANCIAL, LEGAL, REGULATORY, ACCOUNTING OR TAX ADVICE. INDEPENDENT ADVICE SHOULD BE SOUGHT IN CASES OF DOUBT. NEITHER THE INFORMATION NOR ANY OPINION CONTAINED ON THIS SITE CONSTITUTES A SOLICITATION OR OFFER TO BUY OR SELL SHARES OF THE FUNDS OR ANY OTHER FINANCIAL INSTRUMENT. Standard & Poor's®, S&P® and SPDR® are registered trademarks of Standard & Poor's Financial Services LLC (S&P); Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC (Dow Jones); and these trademarks have been licensed for use by S&P Dow Jones Indices LLC (SPDJI) and sublicensed for certain purposes by State Street Corporation. State Street Corporation's financial products are not sponsored, endorsed, sold or promoted by SPDJI, Dow Jones, S&P, their respective affiliates and third party licensors and none of such parties make any representation regarding the advisability of investing in such product(s) nor do they have any liability in relation thereto, including for any errors, omissions, or interruptions of any index.
SPDR ETFs may be offered and sold only in those jurisdictions where authorised, in compliance with applicable regulations.
European SPDR ETFs
SSGA SPDR ETFs Europe I Plc and SSGA SPDR ETFs Europe II Plc are investment companies with variable capital constituted as umbrella funds with segregated liability between sub-funds under the laws of Ireland and authorized by the Central Bank of Ireland pursuant to the European Communities (Undertakings for Collective Investment in Transferable Securities) Regulations 2011.
Information related to Mexico
This information does not constitute and is not intended to constitute marketing or an offer of securities and accordingly should not be construed as such. The Funds referenced herein have not been, and will not be, registered under the Mexican Securities Market Law (Ley del Mercado de Valores) and may not be publicly offered or sold in the United Mexican States. Disclosure documentation related to any of the aforementioned Funds may not be distributed publicly in Mexico and shares of the Funds may not be traded in Mexico.
You should obtain the Prospectus and Key Investor Information Document (KIID) relating to specific SPDR ETFs and read them carefully prior to investing. For further information and the Prospectus/KIID describing the characteristics, costs and risks of SPDR ETFs, download a Prospectus or KIID here, talk to your financial advisor, or obtain it from your local SSGA office.
US SPDR ETFs
The US domiciled SPDR ETFs named on this site are only permitted to be marketed into the relevant EEA jurisdiction pursuant to either Article 42 of AIFMD (as implemented under national laws of such member state); or (ii) can otherwise be lawfully offered or sold (including on the basis of an unsolicited request from a professional/Qualified investor). Some of the US domiciled SPDR ETFs mentioned in this site are alternative investment funds for the purpose of the European Union Alternative Investment Fund Managers Directive (Directive 2011/61/EU) (“AIFMD”). SSGA Funds Management, Inc. and State Street Global Advisors Trust Company are the alternative investment fund managers (“AIFMs”) of these Funds.
Before investing, consider the funds' investment objectives, risks, charges and expenses. To obtain a prospectus which contains this and other information, download a prospectus here, or talk to your financial advisor. Read it carefully before investing.
SPDR® Dow Jones® Industrial Average ETF is listed and registered for sale in the Netherlands