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There is a phrase for it: the soft bigotry of low expectations – the markets’ impulse to dump emerging market assets at the first sign of a crisis.
In the first six weeks of the year, emerging markets felt the full force of traders’ low expectations as the market dramatized the sell-off in equities, FX and rates markets in nations with high current-account deficits. Fears of full-blown and synchronized trouble akin to the Asia crisis of 1997-98 snowballed.
It looked like a return to the dark days of the emerging markets as central banks from Turkey to India were forced to engage in aggressive rate increases, and fears grew over foreign-currency reserve losses exacerbated by policy blunders in Argentina, Turkey, Thailand and Venezuela.
Emerging market assets tend to overshoot on the downside, given their high-beta status, structural illiquidity and the tendency of crossover investors to flee en masse, thereby triggering broader macro fears. Nevertheless, much of the market commentary shifted to hyperbole. The sell-off – inaccurately described as a ‘slump’, ‘carnage’, or ‘indiscriminate’ – had Argentina, which constitutes less than 2% of the MSCI emerging market index, gracing the front pages of western newspapers.