Emerging Market Elections May Increase Market Volatility

Emerging markets have experienced a great deal of volatility this year for a number of reasons, including a stronger U.S. dollar pressuring many emerging-market currencies.

The volatility is becoming more pronounced because many countries have had or are holding elections. By the end of 2018, there will have been 24 elections in emerging-market countries, and each brings the risk of significant policy change. Normally most investors pay scant attention to a country’s election, but these aren’t normal times. Considering the election surprises in Great Britain, the U.S., Germany and other countries, surprises are becoming the rule rather than the exception.

“We think that populism is very much here to stay,” says Amanda Agati, co-chief investment strategist at PNC Financial Services Group in Philadelphia. “It was a big deal in developed markets last year. Populism the across the globe is taking off and that’s not unique to emerging markets.”

Brazil is key. Several market experts say the biggest coming election they’re watching is in Brazil, the largest of the emerging-market countries to go to the polls.

[See: 7 Ways to Invest in Emerging Markets.]

The Oct. 7 election comes as the country is dealing with a deep recession. This year’s contest is rife with uncertainties. The most popular candidate was former President Luiz Inácio Lula da Silva, but he was taken off the ballot since he is jailed on a corruption conviction. His heir apparent and next leading candidate, Fernando Haddad, was charged last month by prosecutors with corruption. Another candidate was recently stabbed.

Sean Newman, senior portfolio manager of emerging markets debt for Invesco in Atlanta, says several other candidates have little legislative or political experience.

“The potential for Brazil to reverse course on its recent progress is pretty significant,” he says.

Agati says aside from being the fifth-largest emerging market, Brazil is the world’s 12th biggest oil producer and is a top producer of other commodities, like coffee and soybeans.

“The election certainly has the potential, depending on how that goes, to impact performance in emerging markets, impact commodity prices and certainly the currency,” she says. “So we do think that elections in general do have the potential to impact the markets.”

Mexico and Turkey examples of election impacts. Newman says he’s also watching developments in Mexico and Turkey. When Andrés Manuel López Obrador won Mexico’s presidential election in July, it weighed on Mexican markets because of concerns that Lopez Obrador, also known as AMLO, might reverse course on several market-friendly key policies, Newman says.

“It’s why you have to carefully manage [your] risk around these events,” he says.

AMLO will take office Dec. 1, and Mexican markets rebounded after AMLO used conciliatory messages and verbally guaranteed that he will respect the autonomy of institutions like the central bank while avoiding further threats to existing oil contracts, Newman says.

Turkey also offers lessons for emerging market investors, Agati and Newman say. Turkey has struggled for the past few years, and the re-election of Recep Tayyip Erdogan has compounded the issue. Newman says Turkey has been one of the worst-performing emerging market countries across all asset types as Erdogan has pursued policies to concentrate power under the executive branch, limiting central bank independence and risking unsustainable growth.

[See: 9 ETFs to Capture China’s Red-Hot Growth.]

“I think the lessons to take from Turkey is that if there is not a clear plan or strategy around interest rates, how monetary policies is going to be set and how fiscal policy is going to support that, the lack of these pillars will make countries more vulnerable [versus] their counterparts,” he says. “If you pour in some political volatility on top of that, it’s certainly a fire that doesn’t need a lot of igniting.”

Uncertainty abounds. Because of all the uncertainty in emerging markets right now, Francis Tapon, chief investment officer and co-founder of Emperor Investments in Toronto, says he’s staying away from the region.

“Things are very fraught, even in the U.S., so for the moment I’m not investing there [in emerging markets],” he says.

But Agati says there could be opportunities in emerging markets once elections are straightened out, noting these are short-term cyclical issues, rather than secular or structural changes.

Emerging markets could get a breather if the Federal Reserve eases up on raising interest rates, as that may cool the dollar’s rise, say Agati and Kristina Hooper, chief global market strategist for Invesco in New York City. Hooper says she expects emerging markets to be under pressure for the rest of the year, although that may dissipate a bit if the Federal Reserve eases up on raising interest rates.

Role of the U.S. More specifically on emerging markets, Hooper says the recent U.S. decision to put additional sanctions on Turkey may be a signal the government is changing its role toward these countries. While the Turkish sanctions were country-specific, she says the U.S. historically played a pacifier role when it came to emerging markets, such as helping to restructure Latin American debt in the 1980s with Brady bonds, named after then U.S. Treasury Secretary Nicholas Brady.

“Brady bonds provided a U.S.-guarantee wrapper around it, so to speak,” she says. “My guess is that we’re not going to see any Brady bonds anytime soon and that an ‘America First’ policy may mean that emerging markets continue to come under pressure.”

Because of the changes in emerging markets, investors need to be choosy about which ones they select, taking a more active approach, rather than selecting a passive index mutual or exchange-traded fund, Agati says.

Emerging markets are also dealing with the potential of trade and tariffs from the U.S., which may hurt some markets more than others. Hooper says she thinks China will be able to withstand some of the U.S. tariffs.

[See: 7 Ways to Shelter from a Trade War.]

“It has an arsenal of weapons at its disposal, from the ability to devalue the yuan to ownership of U.S. Treasurys,” Hooper says. “That’s very significant. If China were to choose not to continue to buy U.S. Treasurys or to sell some of the Treasurys they currently hold, all else being equal, that could drive up U.S. borrowing cost. So that’s a pretty powerful tool.”

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Emerging Market Elections May Increase Market Volatility originally appeared on usnews.com

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