Emerging Markets Losing S&P 500 Link as Growth Slows: Currencies

Apr 25, 2014 4:06 am ET

(For a Currencies column daily alert: SALT FXCOL.)

April 25 (Bloomberg) -- Fresh signs of faltering growth across the developing world are preventing currencies from South Africa’s rand to Indonesia’s rupiah from sharing in gains that sent U.S. stocks to a record this month.

A Bloomberg gauge of 20 emerging-market currencies fell 1 percent since reaching a four-month high on April 10, a span in which the Standard & Poor’s 500 Index rose 2.5 percent amid improving U.S. earnings. The correlation between the two slid to 0.01 yesterday, the lowest since September 2008 and down from as high as 0.72 in March. A reading of 1 would mean they were moving in lockstep, and minus 1 would signal the opposite.

“What we really want is growth out of these guys,” Dirk Willer, the New York-based head of Latin American markets strategy at Citigroup Inc., the world’s second-largest currency trader, said in an April 23 telephone interview. “People are in wait-and-see mode.”

After the worst start to a year since 2009, emerging-market currencies posted a two-month recovery as concern waned that many developing nations were on the verge of financial crisis. Now, foreign-exchange bulls are retreating as the conflict in Ukraine and shrinking demand from China coincide with a slowdown across developing economies. The International Monetary Fund cut this month its 2014 growth forecast for emerging markets to 4.9 percent from January’s 5.1 percent estimate.

Broad Slump

All but three of 24 emerging-market currencies tracked by Bloomberg have weakened against the U.S. dollar since April 10.

Chile’s peso has led the declines, dropping 2.6 percent as the economy shrank amid a slump in investment. The peso fell on April 23 to within 3 percent of last month’s five-year low of 577.1 per dollar. Foreign investors boosted net shorts, or bets the peso will drop further, to $13.5 billion on April 21, from $12.6 billion a week earlier, according to the central bank.

The rupiah, the first quarter’s best-performer, posted the second-biggest loss of the past two weeks, sliding 2.2 percent and touching a seven-week low of 11,658 per dollar on April 23. After a reduction in Indonesia’s current-account deficit spurred the rupiah’s gains earlier in the year, concern that data due next month will show the gap widening again is contributing to its losses now.

‘Subdued Outlook’

“There’s still concern about” emerging-market growth and “about flows to the asset class,” Kevin Daly, a money manager who oversees about $12 billion of emerging-market debt at Aberdeen Asset Management Plc in London, said by phone on April 23. “You still have a more subdued outlook” for the currencies.

Bloomberg’s developing-nation currency index has fallen for two straight weeks, ending a rally from a five-year low reached on Feb. 3. Those gains, in turn, followed a 3 percent slump in January.

The S&P 500 Index, a barometer of appetite for higher-risk assets worldwide, has risen in that time as companies from Apple Inc. to Caterpillar Inc. reported better-than-forecast earnings and drug makers engaged in a flurry of merger activity.

The 30-day correlation between the indexes peaked at 0.9 in December 2011 and has averaged 0.64 over the past five years. The link briefly turned negative, meaning the asset classes were moving against one another, during a worsening in the global financial crisis in 2008.

The extent of investor appetite for higher-yielding assets was shown by the reception to Greece’s oversubscribed, 3 billion-euro ($4.2 billion) bond sale this month that ended the nation’s four-year exile from international debt markets. Spain yesterday sold 10-year debt at the lowest yield on record.

Buying Opportunity

To some strategists, the recent declines in emerging-market currencies are just another reason to buy now. Half of the 24 developing-nation exchange rates tracked by Bloomberg have gained this year, led by Brazil’s real, which climbed more than 6 percent, along with the rupiah and India’s rupee.

Simon Quijano-Evans, the London-based head of emerging- market research at Commerzbank AG, said he recommends the real, rupee and Turkish lira because the benefit investors get from local interest rates -- known as the carry -- is high enough to compensate for the economic risks.

“Why should emerging-market currencies remain on this weak footing, especially when you see global growth starting to pick up?” he said in an April 23 phone interview.

The IMF said April 8 that its downgrade of economic forecasts for countries including Brazil, South Africa and Turkey was a “worrying development.” The organization lowered its estimate for Russian growth to 1.3 percent from 2 percent as investors pulled capital from the country amid speculation the government is backing militants in eastern Ukraine.

‘Weak’ Demand

Citigroup’s Economic Surprise Index for developing countries, which measures growth indicators relative to analysts’ forecasts, fell to minus 27 on April 23, the lowest since August and down from as high as 21 in February.

“There has been little to suggest that EM deserves to trade at higher valuations,” Morgan Stanley analysts led by Rashique Rahman, the co-head of foreign-exchange and emerging- market strategy in London, said yesterday in a note. “Domestic demand conditions still look weak, with a few exceptions, while exports are lackluster much across the board.”

In another sign emerging markets are missing out on gains elsewhere, inflows to exchange-traded funds have dried up in the past two weeks. The $36 billion iShares MSCI Emerging Markets ETF, the most-traded developing-nation stock fund, had a net outflow of $18 million from April 14 to 23, according to data compiled by Bloomberg.

“We don’t see the current environment as being a continuation of what we saw in recent years -- a prolonged period of risk-on, in which every single currency, regardless of its economic fundamentals, benefited,” Marcela Meirelles, a Los Angeles-based strategist at TCW Group Inc., which oversees $136 billion, said by phone on April 23. “People are taking a step back to re-assess where we stand.”