Acomparison of stock market performance in the last one month, in dollar terms, shows that emerging markets, which had earlier been able to beat developed
markets handsomely, posted returns that were at par with those in the developed world. For example, while the MSCI US index is up 2.72% in the month to 8 January, the MSCI Emerging Markets index, too, is up 2.72%, while the India index moved up by 2.53%. This is also the period during which the dollar index moved up from its lows, rising from 74.365 on 1 December to 77.471 on 8 January.
So was the earlier outperformance of the emerging markets the result of a weaker dollar alone? Of course not—higher growth in emerging markets is certainly an attraction. That’s easily seen if we compare the one-year returns in local currency terms instead of US dollars. While MSCI India has gained 92.88%, the US index is up a sedate 26.43%. But curiously, if we take the indices for the three months to 8 January, we find that MSCI US has returned 10.64% while MSCI UK has gained 9.56%, both beating the MSCI Emerging Markets index, which gained 9.21% over the period. Could this be merely because emerging markets had already run up a lot and investors were booking some profits, or was it because the pace of dollar depreciation slowed during the last three months of the last year? While both factors contributed, there’s no denying that the value of the dollar is very important for fund flows to emerging markets.
Notice that the dollar started to appreciate once good news started to trickle in from the US economy, in particular, upbeat data on US payroll numbers in the beginning of December. On the other hand, disappointing US payroll data last Friday led to a fall in the dollar index. A slower recovery will mean that the US Federal Reserve, too, will push back any monetary tightening measures, which should be good for the dollar carry trade.
For fund flows to emerging markets, a tepid US recovery may be the best scenario.