Home / Industry / Energy /  Emerging markets still stuck on oil

Singapore: The Organization of the Petroleum Exporting Countries’ (Opec’s) failure to agree on a production freeze offers the perfect opportunity for emerging markets to show they have decoupled from oil. That’s unlikely to happen.

Optimists have reason for believing that developing-world stocks and bonds are ready to break the unusually high correlation they’ve shown with crude prices in the past year. Bears have retreated from equity markets, with the Morgan Stanley Capital International (MSCI) Emerging Markets Index climbing 22% from its January low, while high-yield bonds have started to move less in lockstep.

Short interest in the largest exchange-traded fund tracking developing nation dollar-denominated bonds has fallen to 2.2% of shares outstanding, near the lowest level since 2012, from 13% in mid-February, Bloomberg News reported. At the same time, the 21-day correlation between Bank of America Merrill Lynch’s High Yield Emerging Markets Corporate Plus Index and Brent crude futures has dropped to 27.2% from more than 60% earlier this year. The current level is much closer to the five-year average of 24%.

There’s another key tailwind for emerging markets: China has fired up all stimulus cylinders, with the broadest measure of new credit rising far more than estimated in March. Beyond that are the dovish sounds from Federal Reserve chair Janet Yellen and the easiest monetary policy in history at the Bank of Japan (BoJ) and the European Central Bank (ECB).

So with Brent crude down as much as 7% on Tuesday, might this be the ideal time for emerging markets to show they’ve detached?

Restrain your enthusiasm. Short interest on the iShares MSCI Emerging Markets Index ETF has been a poor predictor of performance. In the past five years, whenever short interest peaked, the index began to rally; when short interest fell, the index weakened. The opposite should happen.

As for the bond universe, investors are about to be reminded of how painful low oil prices can be. Standard and Poor’s said on Friday that there were 46 defaults across the globe so far this year, the highest number for the period since 2009. Peabody became the latest big energy company to file for bankruptcy last week. As losses mount, junk debt investors are likely to reconsider their exposure to emerging markets or simply sell to raise money for fund redemptions.

As Gadfly columnist David Fickling noted, the last time Saudi Arabia drove oil prices sharply down it helped bring about Black Monday, which in turn prompted a severe crisis in emerging markets. While such a doomsday prediction may seem far-fetched this time around (for one thing, China’s economy is vastly larger than three decades ago), investors are probably wise to remember the potential for disruption.

Emerging markets may still offer value in the long run. Right now, they look ripe for a correction, courtesy of oil prices. Bloomberg

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.
Recommended For You
Edit Profile
Get alerts on WhatsApp
Set Preferences My ReadsFeedbackRedeem a Gift CardLogout