As energy stocks topple the tech industry as the best-performing sector in the Standard & Poorâs 500 index, higher oil prices, which fueled energy stocks' rally, have been bad news for many developing economies in emerging markets.
With oil hitting $70 a barrel for the first time in four years, countries in emerging market economies that import most of their petroleum are feeling the effects as the shock filters down throughout their economies.
Although most economists had anticipated that global growth would continue in tandem with the U.S. economy throughout 2018, after marching in lockstep for the past several years, a new trend is emerging. There are signs that growth in the eurozone has slowed as well as in the economies of emerging markets.
Several factors are at play concurrently that have coalesced to create unfavorable conditions, especially for emerging market funds.
As a measure of the sensitivity of emerging market funds to crude oil prices, the performance of emerging market funds have tended to move inversely to the rising price of crude.
A rising dollar makes dollar-denominated debts more difficult to service for some countries in emerging markets. Unsurprisingly, a similar correlation holds between the dollarâs rise and emerging markets' decline.
The Federal Reserve has been more aggressive about raising rates than most analysts had anticipated. Global growth projections did not factor in the four increases in the federal funds rate, which was greater than the largely anticipated three for 2018.
The policy of the Fed has ramifications for the world's economies, especially for those who hold dollar-base assets or debt. When the Fed tightens the money supply, eventually this impacts Europe and emerging markets
As an indication of how rapidly emerging markets are diverging, based on data provided by FactSet, the iShares MSCI Emerging Market (EEM, Financial) fell 3.6% this week and is down 7.3% for the month. This represents the fund's worst weekly decline since March 23, when it declined 4.7%.
The difference between the growth rates in the U.S. and the rest of the world is indicated by the performance differential between the iShares MSCI EAFE exchange-traded fund (EFA, Financial), which excludes the U.S., and the S&P 500 index, which is down 5.4% so far this year, while the S&P 500 has returned 1.3%. Calamos Investments contends the divergence has been caused by a combination of the actions by the U.S. central bank and fiscal policy undertaken by the Trump administration, notably corporate tax cuts, have helped to deepen the rift between emerging market economies and Europe on one hand, and the U.S. on the other.
According to Michael Grant, head of global long-short at the Calamos Phineus Long-Short Fund, âThe U.S. dollar is a symbol of the revival of âdomestic Americaâ and the credibility of monetary normalization.â
Grant says âevery extended period of U.S. dollar strength since the 1970s has been associated with the leadership of U.S. equities, measured in common currency.â
Look for the current gap between the U.S. and the worldâs economies to widen as some forecasters expect the U.S. economy to exceed growth projections for the third quarter.
Based on the report issued by the Commerce Department on Wednesday, some economists have upgraded their projections for second-quarter growth, from 4.6% to 5.3%. Should this forecast prove accurate, it would be the strongest quarterly growth reading since 2003.
Disclosure: I have no positions in any of the securities referenced in this article.
