By James Mackintosh
Janet Yellen is an unlikely Goldilocks, but the Federal Reserve chairwoman has finally chased the three bears away from emerging markets. The jump in EM stocks and currencies after her slightly dovish comments on Wednesday means that after almost 10 years, investors who put $1,000 into the MSCI Emerging index at the 2007 peak now have $1,000 again, before fees and tax, assuming they reinvested their dividends.
There are lessons here about central banks, emerging markets and, unexpectedly, technology stocks.
The first is that markets are particularly prone to over-interpret central bank comments, as investors worry that almost a decade of easy money is coming to an end.
Comments by Bank of England Gov. Mark Carney and European Central Bank chief Mario Draghi in Sintra, Portugal, two weeks ago turned into a Sintra conspiracy theory of coordinated global tightening, helped along by the Bank of Canada and others. The market priced in higher interest rates even as inflation expectations fell.
Ms. Yellen's testimony to Congress on Wednesday suggested investors had made a mistake. Sure, the Bank of Canada had indeed turned hawkish, raising rates for the first time in seven years, but Ms. Yellen made clear the Fed would change course if recent weak inflation persists. If there's a global conspiracy for tighter money even in the absence of inflation, the Fed isn't part of it.
The second lesson is that this matters for emerging markets. Many investors have been arguing that there will be no repeat of the 2013 "taper tantrum" that hit EM stocks, bonds and currencies. The thinking is EM countries are better prepared this time. But if EM currencies, bond prices and stocks rise when Ms. Yellen is a little bit dovish, that strongly suggests they will fall if she turns hawkish.
A fall doesn't equate to a tantrum, but sensitivity is high. On Wednesday, Ms. Yellen's comments prompted a 0.04% drop in the 10-year Treasury yield, and a rise of about 1% in EM local currency bond prices, in dollar terms. If the link between the two stayed the same, and Treasury yields rose as they did in 2013, EM bonds could repeat the 20%-plus drop of 2013.
The third lesson is that the performance of tech stocks depends in part on the Fed, and in turn, is vital to EM investors.
Stories justifying tech companies are about disruption -- of media, retail, cars, or in the case of AI, everything. But the Fed also matters, because tech firms are high-growth companies that ought to be able to increase profits even if the economy does little.
Profits far in the future are worth more when interest rates are low, so tech stocks are more sensitive to rates than others. Equally, a weak economy -- one cause of low rates -- leaves a dearth of fast-growing companies, making tech stocks one of relatively few options for investors who want to chase growth. Bring back growth, and there is less need to pay up to hold expensive tech stocks.
Tech stocks have performed wonderfully so far this year, with the sector leading the S&P 500, as hopes for a U.S. stimulus faded. The same was true Wednesday.
Tech, in turn, matters to EM, because the vision many have of emerging countries as poverty-stricken and backward isn't accurate -- at least as far as the main stock market index goes.
Technology is now the biggest sector in the MSCI Emerging index, and five tech companies alone make up 17% of its value. Three of those -- South Korea's Samsung Electronics, Taiwan Semiconductor Manufacturing and Taiwan's Hon Hai Precision Industries -- are in countries richer per capita than Italy, adjusted for purchasing power parity.
Four of the five big EM tech companies are up more than 46% in dollar terms this year, with Alibaba, China's answer to Amazon.com, up 70%. Even laggard Taiwan Semi is up 23%. All suffer the same sensitivity to the economy and interest rates as America's tech giants, as they demonstrated after the U.S. election briefly brought rising bond yields and hopes of economic stimulus.
Investors even in such apparently diverse areas as technology and emerging markets have little choice but to be Fed watchers. EM shareholders can reasonably hope that the next decade is more rewarding than the last, but they shouldn't rely on the Fed keeping the bears at bay.