U.S. Pain Can Be Emerging Markets’ Gain

Even a brief pause in the U.S. rally could be just what the doctor ordered for developing countries, and not a moment too soon.

U.S. Pain Can Be Emerging Markets’ Gain

A U.S. correction wouldn’t necessarily be a bad thing for emerging markets.

Photographer: Michael Nagle/Bloomberg
Photographer: Michael Nagle/Bloomberg

Emerging markets are reliving their 2015 nightmare. A U.S. stock correction may be just the thing to rouse them. 

Three years ago, developing countries’ stocks lost almost a quarter of their market value in the months from October to January. China’s foreign reserves slid as Beijing scrambled to stem a flood of capital outflows. Meanwhile, a hurriedly implemented circuit breaker, intended to halt mainland A-shares’ decline, turned out to be futile.

Now we are seeing a similar slump, albeit at a slower place. U.S. stocks, by comparison, have hardly seen a correction.

Recurring Nightmare

Emerging markets' 24 percent drop so far this year mirrors the slump of early 2016. The U.S. market, by comparison, has hardly seen a correction.

Source: Bloomberg

The S&P 500 Index has benefited from an “America First” mentality. The Federal Reserve is on track to hike rates four times this year, followed by two more in 2019. The $3.5 trillion of easy money unleashed by the U.S. central bank’s quantitative-easing program, a good chunk of which went toward higher yields in emerging markets, are now poised to come home. With all signs pointing higher, stocks seemed like an obvious place to put your money.

So this pause in the S&P’s record bull run — even if it’s brief — could be just the thing to slow developing nations’ outflows. 

Some pockets of the emerging-market sell-off are looking increasingly irrational, anyway. 

After Bloomberg Businessweek reported last week that China used a tiny chip to infiltrate U.S. servers, a new twist to the escalating trade war, investors dumped Chinese hardware makers — so much so that it seems they no longer expect China Inc. to generate any overseas sales at all. PC maker Lenovo Group Ltd., which gets 17 percent of its profit from the U.S., has lost almost a quarter of its value. Similarly, surveillance-camera maker Hangzhou Hikvision Digital Technology Co. tumbled 17 percent over the same period, despite negligible sales in the U.S. 

In the event of a “total trade war” — in which the U.S. would stop buying all Chinese-branded electronics, and Beijing would reciprocate — American brands stand to lose $43 billion a year, 2.7 times China’s loss, according to CLSA. If the sell-off deepens, it should really be on U.S. soil. 

During this week’s roadshow for its dollar-bond sale, China’s Ministry of Finance painstakingly pointed out that many U.S. multinationals — including Apple Inc., Tesla Inc., Starbucks Corp. and Boeing Co. — get a sizable chunk of their sales from the mainland. That amounts to a thinly veiled threat: Beijing has the leverage to cause a serious correction in U.S. stocks. 

Veiled Threat

In a total trade war, China could put a serious dent into U.S. multinationals' earnings

Source: China Ministry of Finance dollar-bond presentation

As I argued recently, valuation premium between the U.S. and emerging markets has reached a historical peak. Developing economies may not be playing catch-up now — because liquidity there is still tight — but it’s high time for U.S. stocks to come back down to earth.

Tide Out

Financial conditions in the U.S., a good indicator of stock-market performance, tightened sharply in October

Source: Bloomberg

Note: Bloomberg's financial-conditions index tracks the overall level of stress in the bond, stock and money markets to assess the availability and cost of credit.

And that’s not necessarily a bad thing. Stubbornly persistent outperformance of one market could spell trouble as the world’s most prominent central bank continues to mop easy money off the floor. We are now in a zero-sum game. 

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    Shuli Ren at

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    Rachel Rosenthal at

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