Emerging Markets, Good Long-Term Prospects. In the Short Term, Volatility Will Test Investors

Market volatility will remain elevated, reflecting the uncertainty generated by U.S. policy and communication regarding the war against Iran.

by Marcel Zimmermann, manager of the Lemanik Asian Opportunity fund

Asia, which is heavily dependent on the Middle East, is suffering the current situation the most, with the MSCI Asia index down 13.62%. The shortage of energy and the rise in prices will become more acute as the war against Iran continues to block the Strait of Hormuz and production facilities in the Middle East. We therefore need to keep focusing on the long-term prospects of emerging markets, which continue to underpin and increase their weight and contribution to growth within the global economy.

Global financial markets have faltered under the weight of negative news from the war in Iran. Oil prices surged following the closure of the Strait of Hormuz, attacks on oil facilities in the Middle East and the erratic flow of news from the President of the United States about real or fictitious negotiations. The risks of higher oil prices and a prolonged closure of the Suez Canal shook all asset classes. Long-term yields surged, the U.S. dollar benefited from its safe-haven status and equity markets fell. The geographical picture reflected dependence on oil and gas flows from the Middle East.

The United States, a net exporter, saw the S&P index fall by only 5.09%, Europe recorded a decline of 9.26%, but Asia, which is highly dependent on the Middle East, suffered the most from this crisis, sending the MSCI index tumbling. The strong overweight position in Korea affected the monthly performance, as did our currency hedge against the rise in the U.S. dollar. Nevertheless, we maintain a positive and constructive view of the Korean market and see potential for multi-year outperformance, as the government is promoting major regulatory changes to reduce the «Korean discount» in its equity market.

Looking at Asia as a whole, the countries most heavily dependent on oil and gas from the Middle East are Japan and South Korea, while India, China, Indonesia and Malaysia source about 50-60% of their imports from that region. The risks of higher inflation in Asian emerging markets are also weighing on their currencies. The Bloomberg Asia Dollar index fell 2.9% over the month. This is undermining the renewed confidence of global investors in increasing exposure to equity securities in emerging markets.

We took profits on our positions in Japan and South Korea, trading close to their 12-month target price, and used the current market weakness to buy value and defensive companies in South Korea and Japan. In China, we bought oil services companies as we expect a recovery in Chinese investment in local and overseas markets after the war. Overall, market volatility will remain high and test investors’ patience, reflecting the uncertainty generated by the inconsistency of U.S. policy and communication regarding its objective in the war in Iran.