08/05/1998 16:00:26 EMERGING MARKETS-Dow seen dominating trends
By Diane Craft
LONDON, Aug 5 (Reuters) - Emerging financial markets once
again have chosen to trade in line with the lowest common
denominator -- this time the plunging U.S. stock market -- and
analysts say that trend is likely to dominate in the short run.
Over the past two days, both emerging equity and debt
markets have tumbled as the Dow Jones Industrial Average shed
nearly 400 points, or roughly four percent of its value.
"It's looks as if whichever way you turn emerging markets
face one problem or another -- if it's not the yen, it's the
U.S. equity market," said Geoffrey Dennis, global emerging
market equity strategist at Deutsche Morgan Grenfell in London.
By the close of trading on Tuesday the International
Financial Corporation's Composite index, which tracks 1,414
stocks across emerging markets, was off 2.64 percent from
Friday's levels at 205.26.
The Brazilian Bovespa index registered Latin America's
sharpest losses, falling by 7.92 percent since Monday to 9,859.
Even emerging market debt, once heavily correlated with the
U.S. Treasury market, has followed the Dow lower.
Yield spreads on the closely watched J.P. Morgan EMBI
emerging debt index have widened to 656 basis points over the
stripped curve of the U.S. Treasury market since late Friday,
when the index closed at 621 over.
That compares with 461 over on April 30, when the Dow ended
some 576 points higher than Tuesday's closing level of 8,487.31.
Analysts said emerging financial markets would continue to
trade in line with any indicator which smacked of risk -- be it
the U.S. equity market or the dollar/yen rate. Risk aversion had
become the catchphrase for investors who were badly burned by
the Asia crisis.
"It's not the case that slower growth in the U.S. is going
to have a direct impact on these markets, but the key is
investor behaviour," said Sonja Gibbs, chief strategist for
emerging Europe at Nomura Securities.
"If the perception grows that equities are becoming more
risky, naturally it will affect markets perceived as most risky
Dennis said investors would not want to look at emerging
markets if the Dow continued to fall because they would again
run for cover to safe havens such as the U.S. Treasury market.
"At this precise moment, this is not good for emerging
markets. If we get further short-term declines, I think emerging
markets are going to struggle," he said.
Peter West, chief economist of BBV Securities, said a
rebound on Wall Street would steady investor's nerves but
sentiment towards emerging markets would grow even more negative
if U.S. shares continued to slide.
"With the Dow Jones going down, it will add to deflationary
worries in the world economy, and that makes things worse for
commodity producers in emerging market economies in general, and
their financial markets," he said.
But analysts said investors should not panic too much,
because the underlying economic fundamentals in Latin America
and emerging Europe remained favourable.
"It's a sign of nervousness globally that we are following
the Dow more than anything else," said Jerome Booth, head of
emerging market research at ANZ Investment Bank in London,
referring to emerging debt markets.
"Once people calm down a bit, you will see that relationship
cease and the new motivating force in our market at some time in
the next few months will be the desire to have high yield."
Booth said many investors were waiting on the sidelines.
"It's a fantastic time to buy the market because it is
oversold, but having said that, short-term there is still some
market risk," he said.
Other analysts said the herd mentality towards emerging
markets should start to dissipate as long as a financial
earthquake, such as a collapse in the Dow to the 7000 level or a
Chinese currency devalution, did not occur.
Gibbs said domestic factors should come into sharper focus
and a two-tiered structure was likely to emerge, with the
riskiest markets suffering most.
Dennis agreed: "I don't think the markets will rally today
but I do think investors should pick up shares in quality
markets in the next few days on weakness, and I mean markets
like Brazil, Argentina, Poland, Greece, Portugal and Hungary."
But he added: "I don't mean Asia, because I think Asia is
going to underperform." ((London Newsroom, 44 171 542 5110,
fax 542 8688, uk.emergingmarkets.newsreuters.com))