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Market Review: Developing Markets
The sunny optimism that had surrounded markets so far this year fell away rather sharply in May. The background rumble of distress in the sovereign markets of peripheral Euroland got louder and was reinforced by some negative developments in the emerging markets as well. Volatility also returned with a vengeance.
The stock markets fell from the start of the month, dropping an aggregate 17% from the end of April to their lowest point. Having become so oversold so quickly, the last week of May saw a retracement of nearly half this loss, resulting in an index decline of 9%. The damage was fairly widespread, with markets taking up their characteristic roles: volatile markets like Russia, Turkey and Brazil led the fall, while the more defensive countries like South Africa, Chile or Mexico fared much better, at least in local currency terms. Currencies too fell against the dollar in a reflection that the declines were really a flight from general risk.
In specific news the situation in the Korean peninsula was particularly unsettling, with threats by the North adding to what was already a rather nervous state of affairs. Further tightening measures in China (and other countries as well) were in sharp contrast to the deflationary tone in most of the developed world, and led investors to worry about a slowdown in the Chinese growth engine. Combined with the perilous state of the Euro, all this was too much for investors and there was the first serious setback since the lows in March 2009.
While there is concern that the sovereign crisis in Southern Europe might lead to a Lehman-style liquidity problem, European governments appear determined to head this off through quantitative easing should it be necessary. Political indecision and coordination failures remain significant risks, however, and markets may well remain volatile.
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