ETFs have a new acronym.’Emerging Traded Flows’. That probably captures their new found lust for emerging markets. Going by the sudden gush in their flows into emerging markets over last few weeks, it would appear that they have switched their loyalty back to EMs with a vigor. Exchange Traded Funds have always been spot-on in capturing the changing tides. No different this time.
But the scale of switch has surprised even the most optimistic ones. Just to put this in perspective, FIIs poured as much just in two months in Indian equities as what they took out over last 6 to 7 months. The make-over was really in March. It witnessed one of highest inflows (near 30K Cr) for any month since the bull-run started in 2014. This is on the top of $2Bn dollar flows markets received in the month of Feb. Needless to say that much of this is from ETFs. This is not anything unique to India.
Emerging markets as a basket have witnessed frantic flows since the dawn of the New Year and India is only catching up on the broader EM trend. India may still have more headroom on the catch-up going by the sharp surge in the broader emerging market indices (MSCI-EM index is up by over 10%). Hopefully, one can now heave a sigh of relief that tide has at last turned for EM flows.
While this is heartening, what is more amusing is when one sits down and decodes the dynamics behind these changing tides, hardly one finds rational reasons for such wild swings. In searching for answers to questions like why did EMs lose favor in such a fanatical fashion in 2018 or why the flows are back with feverish fervor in 2019, here are some interesting insights gained on the way from the riveting theatrics of market tantrums in 2018.
It all starts with Fed
All EM cycles have an eerie connect with Fed. The 2018 cycle was no different. To appreciate the magic of this reoccurring cycles, start with the steaming US economy. Add the prospect of overheating and rising inflationary risks. Then rope in the ingredients of surging US markets and rising risks of acceleration in rate hikes. With all these, the stage gets set for high decibel narrative that fuels fears of heightened Fed rate hikes. Dollar starts strengthening on this prospect (of accelerated tightening) which in turn leads to money gushing out of EMs. What follows is the mayhem in EM currencies and EM equities that feeds on to itself in a vicious cycle to result in deadly correction across the emerging markets. In other words when Fed sneezes, EMs catch cold.
ETFs excel in crowded trade
The question is not so much about what triggers the EM crisis, but why it has such a devastating impact on the currencies and stocks? In a related question, why does money move out in such a frantic fashion, only to return not long after? The answer to this intriguing question, probably lies in the nature of the so called ETF beast. This beast loves company, that too a crowded one. Not to be left behind, it hurries and hastens all the time where the herd is heading. Because this beast is hugely muscled up with money, it’s in and out movement can wreck markets. That is what happens in every such EM cycle.
Price action leads, narrative follows
More interesting is how price action sets the narrative during these cycles. It is amazing to see how negative momentum in prices brings plethora of problems that have been otherwise dormant to the surface. When EM flows are on upswing, common structural macro issues such as current account deficit, fiscal deficit and inflationary risks etc. get buried beneath while the sharp reversal in flows pops these out in a paradoxical manner. When they are brought out, the damage they inflict on the macro metrics including currencies are quite severe, though some of these could be a welcome overdue adjustments as happened in the case of Rupee.
In the end, nothing material happens:
In the entire EM play, the script plays out in a gripping fashion, plot thickens in unpredictable twists, yet, nothing material happens in the end. It starts with fears of accelerated hikes, but ends with hopes of extended pause or calibrated cuts from Fed. To understand this more, one doesn’t need to look beyond what US 10 year yield has done over last 12 months. It was 2.7% to start with in April last year. It moved up and up to 3.25%+ by Nov’18 on fears of accelerated hikes only to retrace to 2.4% now on renewed hopes of extended pause (worst case) or moderate cuts (best case). That much for EM crisis that gets blown out of proportion by heightened ETF pullouts. This is not one off. It repeats now and then, sometime in too predictable fashion, but in a painful way. Lots of money gets made in every such market cycle, be it 2008 or 2013 or now, by wise and shrewd investors who have honed their skills to focus on the price action (cycles), not on the narrative (noise).
(ArunaGiri N is Founder CEO & Fund Manager , TrustLine Holdings. Views expressed are author’s own)