It has been a painful ride in emerging markets this year, with inflation-related protests in Brazil, political unrest in Turkey and a slowing economy in China. The Federal Reserve’s suggestions that it may soon taper the liquidity fueling investors’ appetite for emerging markets didn’t help either.

The road ahead will likely be bumpy, as countries like China face structural challenges in transforming from an investment-led economy to one driven by consumption, and others, like Brazil and India, struggle to enact structural reforms. An improving U.S. economy and stronger dollar likely mean emerging markets will trail the U.S. Outflows could weaken some currencies further, sparking inflation in countries with large current-account deficits such as Turkey and India.

Does The Emerging Markets Rout Continue?

Citi in the recent report highlighted that Emerging Markets continue to perform poorly across asset classes, countries and regions . In some cases moves have been relatively extreme. For example in equities where a ratio of EM to DM prices is now near the lows of November 2008 and breaking lower, or in Emerging Market local rates where nearly all last year’s gains have been given back in parts of the yield curve.

emerging markets

Weaker fundamentals and growth outlooks

Citi bias so far has been that Emerging Market asset prices could/need to fall further to reflect weaker fundamentals and growth outlooks.Furthermore, emerging countries must attract external capital for the first time in over a decade  and, with private sector balance sheets starting to look stretched  and public spending swelling, this is proving tough .

Rising global bond yields have exacerbated the outflows from Emerging Markets

Emerging markets equity funds witnessed their biggest exodus in almost two years as concerns over the U.S. Federal Reserve cutting back on monetary stimulus and deteriorating growth prospects led investors to exit risk assets. Ultimately Emerging Market may need some combination of higher relative yields, cheap/cheaper currencies and higher relative equity risk premia to attract capital again.

Very short term investor positioning

Very short term investor positioning seems more favourable after the shake out in recent weeks  and recent trading sessions have shown some stability in some higher beta names like MXN and HUF for example despite an interest rate cut in the latter this week. Anecdotally however, Citi also understand that real money redemptions have been relatively small so far, with most of the correction in Emerging Marklet driven by fast money investors.

How bad can it get

Major “breaks” in time series from past Emerging Market crises means that determining fair value in EM asset markets is more an art than a science. Limited data further restricts Citi’s ability to compare asset prices in the current cycle with earlier ones. The short  answer to “how bad can it get” is that there is probably more room to go across EM asset markets.