Four Trends in Nine Weeks: Emerging Stocks on Roller Coaster

(Bloomberg) -- In 2000, it was Europe. In 2011, it was the U.S. This year, it may well be emerging markets.

Every once in a while, a year comes along to take equity markets on a roller-coaster ride. Market trends shift so often that money managers' investment themes, convincing at the start of the year, look outdated by the end of the first quarter.

Two months in, 2018 is already developing into that sort of year for developing-nation stocks. There have been four distinct trends in the past nine weeks and there's no indication which subgroup or national market could outperform its peers.

Initial Surge

The MSCI Emerging Markets Index had its best start to a year since 2012. The average price-to-earnings ratio for the index's companies crossed a multiple of 13 for the first time in eight years. It was in all in line with what most money managers and analysts had believed 2018 would be for developing nations: yet another period of outperformance over developed markets.

They had bet that the gauge would advance about 10 percent by the end of the year. It hit that threshold Jan. 26. While the end-of-year prediction by bulls may still hold true, the declines that followed lent equal credence to bears. They claimed the rally that began in January 2016 has run too far and may wind down. They cited the potential for the Federal Reserve to raise interest rates quicker than forecast and the associated strength in the U.S. dollar to be the main drivers.

For two weeks since late January, the pessimists had the upper hand. So much so the emerging-market index erased all its gains for the year. Options traders succumbed to the pressure and the expected volatility on the stocks doubled.

While the swing itself had been much anticipated -- even welcomed -- by bulls, the worrying factor was how the best performers of the first phase turned out to be the worst in the second.

• Chinese shares listed in Hong Kong had led the year's opening rally, but were the main drag during the slump. The two-way moves in Tencent Holdings Ltd. and Alibaba Group Holding Ltd. pretty much summed up the dilemma for investors.
• Asian shares are now underperforming the EMEA and Latin American regions and are the only group to have fallen on a year-to-date basis. In China, stocks took a hit from concern over tightening financial conditions, a brewing trade war with the U.S. and a slowing economy. In India, it was the disappointment around state-run banks, which are weighed down by bad loans and a $2 billion scandal rocking parliament.
• Meanwhile, equities in Russia, South Africa and Turkey are rallying. Investors typically flock to these markets when there's a lull in political turmoil, often self-imposed by the governments, and flee at the first sight of trouble. The extra volatility that this year has brought has made them only more unpredictable.
• Latin America has left everyone behind, so far. But between impending elections and Donald Trump's tweets, it's quite likely the coming months could be quite different for markets from Brazil to Mexico

Looks Familiar

European stocks faced a similar phase in 2000, when there were many micro trends but no direction to the market. Investors were still figuring out the stability of the euro, which had been introduced only a year before, and there was unease after a five-year rally when stock prices had tripled.

In 2011, it was the turn of the U.S. Expanding Fed stimulus was overshadowed by a downgrade of U.S. debt by S&P Global Ratings and oil prices that fluctuated between a 26 percent gain and an 18 percent loss during the year.

So, the big question in 2018 isn't whether the emerging-market rally will continue. It well might. It's who has the nerve to stick it out until the very end.

To contact the reporter on this story: Srinivasan Sivabalan in London at ssivabalan@bloomberg.net.

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Joanna Ossinger

©2018 Bloomberg L.P.