Emerging Markets Are 'Closer to Wall St'

Financial News, July 27, 2002 | Go to article overview

Emerging Markets Are 'Closer to Wall St'


Byline: Ben Wright

A new paper by investment consultant Watson Wyatt says that emerging market investment may not provide investor protection during volatility in mainstream markets.The paper, Emerging markets equities - is there a case for investing? says: "The non-correlation argument needs closer analysis in the light of events over the past few years. If emerging markets really are uncorrelated, then a crisis in one country should be a fairly isolated event, with little knock-on effect on other markets."

Traditional thinking suggests that emerging markets offer strong diversification attractions, as returns are relatively uncorrelated with each other as well as with the developed markets.

Hans Hamre, associate director and lead global emerging markets analyst at Standard & Poor's, last month said: "Despite recent outperformance compared with their developed counterparts, emerging market valuations remain attractive and this is underpinning interest in the asset class - in the absence of compelling opportunities elsewhere."

Watson's report undermines the diversification argument and argues there is a high level of contagion between the markets, particularly in times of economic strife.

Watson cites the sharp devaluation of the Mexican peso in 1994 which had a profound effect on other emerging markets. When the Thai baht came under pressure in 1997, the subsequent market crash spread to other countries in South-east Asia, and beyond to Russia.

There is a growing argument, presented by Watson, that emerging markets are more closely linked to the fortunes of Wall Street than previously thought.

Watson Wyatt found, by plotting the two-year correlations of the emerging markets with global developed markets, that the relationship with developed markets has steadily risen over the past decade.

From the data, it appears that in times of crisis, either in developed or emerging markets, the two sectors become increasingly correlated. This contagion is exactly what investors do not want.

Craig Baker, senior consultant at Watson Wyatt, says: "The clearest indications of this were following the US rate increase in early 1994, and during the 1997 to 1998 emerging market crisis. …

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