The ‘All Clear’ Memo Didn’t Reach Emerging Markets

Regulatory filings show that hedge funds in the first quarter more than doubled their investments in the three largest exchange-traded funds that buy stocks in emerging markets. Too bad. On Thursday, the MSCI EM Index fell to its lowest since mid-January even as the broader MSCI All-Country World Index surged the most since the start of April.

There are some valid explanations for the underperformance, namely the renewed strength in the dollar and gains in oil, both of which are seen as a drag on emerging-market economies. Even so, it’s still a bit shocking to see emerging-market assets post an outright decline when the broader market is enjoying a strong rally. And this isn’t a one-time phenomenon. The MSCI EM Index has severely underperformed the broader market since mid-April, declining almost 8% despite a dovish Federal Reserve. As a general barometer of risk sentiment, this should be concerning to anyone betting that the escalating trade war between the U.S. and China will be resolved in short order and the fallout contained. “Even if these trade tensions are solved for now, I think in the future there will be further escalations,” Jim O’Neill, the former Goldman Sachs Group Inc. chief economist and coiner of the BRIC acronym, told Bloomberg News. “Economics can be criticized for a lot of things, but one essential core aspect of international economic theory is that trade is in aggregate a win-win and less trade is a lose-lose.”