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Did Fed really hurt emerging markets?

By Sheyna Steiner · Bankrate.com
Thursday, January 30, 2014
Posted: 4 pm ET

It was inevitable that the end of quantitative easing would cause some consternation in emerging markets. The stimulus provided by the central bank has had a depressive effect on the value of the dollar, which encourages investment in riskier markets.

As U.S. interest rates rise, less stable currencies are going to fall relative to the dollar. Falling currencies tend to spark inflation that prompts central banks to tighten monetary policy in such a way that impedes future growth. That partly explains what has been happening in emerging markets the past few weeks.

For instance, the iShares MSCI Emerging Markets ETF is down 9.61 percent this month. The ETF tracks an index developed by MSCI.

On Tuesday, Turkey's central bank announced a rate hike in an attempt to shore up its currency, as did South Africa. Today, Bloomberg reported that investors are bailing out of emerging market ETFs at record rates and some blame is being assigned to monetary policy in the United States.

The Fed's first mention of tapering was a catalyst for the emerging market sell-off in May 2013, but the January sell-off in emerging market currencies and stocks can't be entirely pinned on the Fed, says Peter Lazaroff, CFA, CFP, portfolio manager at Acropolis Investment Management in St. Louis.

"I think the most recent declines are fueled by the concern that central banks in emerging markets that are tightening monetary policy won't be able to do enough to protect their economies against an exit of investor money. Even though these higher rates were supposed to entice investors to keep investing in emerging markets, the toll that higher interest rates can have on economic growth may be too high," he says.

The Fed isn't entirely without blame, though.

"In some regards they were an enabler to countries relying too much on external capital because yield-hungry investors were giving policy makers in those countries the flexibility to put policy in place that is coming back to hurt them now that capital is flowing out," Lazaroff says.

That doesn't mean investors should join the exodus

Investors in developing countries are exposed to more political risks than those in developed nations, in addition to heightened risks from inflation and currency fluctuations.

That being said, holding some broad allocation to emerging market stocks can be a good idea for investors despite recent news of tumult and sell-offs.

"The investment thesis for emerging markets on the whole is still really strong. They definitely deserve a position in portfolios for long-term investors due to their ties to global growth and the diversification benefits," Lazaroff says.

"The demographics are so strong and the fundamentals are superior to many of the developed markets out there. For people who were underweight before the swoon, maybe this is welcome news because valuations are so low," he says.

How do you feel about your global investments today?

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Follow me on Twitter: @SheynaSteiner.
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Senior investing reporter Sheyna Steiner is a co-author of "Future Millionaires' Guidebook," an e-book written by Bankrate editors and reporters. It's available at all the major e-book retailers.

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