Why Weaker Dollar & Low Crude Oil Could Push EM Higher

Emerging markets are countries
that have demonstrated significant growth in the past few decades. In the past
few years, these countries have become the focus of investors because they
expect them to continue overperforming. In the past, terms like BRICS (Brazil,
Russia, India, China, and South Africa) have been coined to illustrate the
best-performing EM countries. In 2018, EM countries were hit hard by a number
of factors.

First, while a strong dollar made
it better for them to do external business, it has some drawbacks. For example,
with US rates rising, investors in EM countries took their money out of the EM
countries to where the yields are better. This limits the foreign direct
investments in these countries. Second, most of these countries have a lot of
dollar-denominated debt. A stronger dollar makes it more expensive for them to repay
their debt.

In 2018, emerging markets had a
tough period with most of them seeing their currencies depreciate against the
USD. The chart below shows the performance of a number of EM currencies in
2018. The decline in the EM currencies was mostly because of a strong dollar,
which was so because of the continued Fed tightening. Another reason was the
impacts of the trade war, which affected global growth. Another less-talked issue
was on the US tax cuts, which led to capital flight from these countries to the
United States. With business conditions being better in the US, a number of
companies preferred being invested there.

As you can see, the Turkish Lira
was among the worst performers. At its worst, the currency dropped by more than
80% against the USD. This was because of the above factors. Another reason was
because of the continued arrest of an American pastor. This led to more tariffs
from the United States. When he was freed, and the role of Turkey in aiding the
investigation of the murder of Jamal Khashoggi led the currency to improve
slightly.

In the coming year, the Emerging
Market countries could perform better. This is because there is a likelihood
that the world will have a truce on trade. Already, US and Chinese officials
are negotiating on how to address the key differences. A deal will lead to more
trade and more confidence among businesses. Second, there is a likelihood that
the USD has peaked. This is because the Fed will likely pause on more interest
rate hikes. Already, the Fed chair has said that the neutral rate is
approaching. This coupled with the increased volatility in the market could
lead the Fed to halt or slow the rate hikes. Third, and most importantly, with
EM stocks being oversold, there is a likelihood that a number of international
investors will go to bargain hunting. This will likely see flows in these
markets rise. Finally, the low crude oil prices will continue providing support
to the countries.

However, the emerging market
countries don’t see a synchronized growth. As shown in the chart above, the
degree of variability differs. Therefore, before you invest in any EM stock or
currency, it is important for you to take time and do your research. This will
help you find opportunities and avoid the common mistakes. Also, it is
recommended that you focus on trading instead of investing. This will help you
avoid the mistake of future uncertainties.

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