Emerging stock markets may topple if the U.S. federal funds rate tops 6%, warns David Shaw, strategy director for Legal & General Investment Management, London.
While emerging markets have grown a cumulative 260% in the past five years compared with only 30% for developed countries, performance has varied greatly by region. Latin America has topped the list at 650%, followed by Asia at 185%, and Europe and the Middle East virtually unchanged.
The five-years can be broken into three periods of sharp price gains followed by nearly identical setbacks of 22% each. Unlike the first two, the latest downturn affected all three regions.
Now, despite strengthening economic fundamentals, global liquidity flows are close to a cyclical peak, and emerging market valuations no longer are cheap, Mr. Shaw wrote to clients. While a 20% rise in emerging markets' stock prices is possible, he worries hiking the federal funds rate to more than 6% would cause U.S. individual investors to seek liquidity, and to pull money out of mutual funds.
"If that were to coincide with the peaking of the global corporate earnings cycle, then a major setback in emerging markets could occur," he wrote. If the IFC Composite Weekly Investibles index of emerging stock markets reaches 400, sell, Mr. Shaw said.