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Emerging Markets Currencies Look Cheap – Time To Go Long?

Posted: Thursday, November 12th, 2020

Estimated Reading Time: 2 minutes

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At the start of the trading week, positive COVID-19 vaccine news sent the values stocks on a move higher. Investors realized that a vaccine means the end of the recession. Therefore, the rotation out of safe-haven assets began – will the emerging markets currencies benefit from such rotation?

Since the pandemic hit the Western world, financial markets reacted in unison. First, the lack of U.S. dollar liquidity triggered a rush for the greenback. Next, the Fed intervened, and the U.S. dollar got sold aggressively.

One of the sectors that benefited the most from the shift in both consumer behavior and monetary policy was the tech sector in the United States. It acted as a safe-haven during the health crisis. So did gold or Bitcoin – alternative investments that typically rise in value during economic contractions.

The more obvious it became that this is not a regular contraction but a recession or even depression, the more the U.S. dollar began to act as a safe-haven against emerging markets currencies. Therefore, the dollar fulfilled two functions. On the one hand, it was dumped against safe-haven (e.g., CHF, JPY, gold, Bitcoin). On the other hand, investors sold emerging markets currencies to find safe-haven in the greenback.

Emerging Markets Currencies

A Case for Emerging Markets Currencies

If the above-mentioned rotation is true, investors might find emerging markets currencies appealing. Yet again, the rotation out of safe-haven and into emerging markets currencies makes sense during expansionary times in the Western world.

However, the stock market typically turns ahead of the business cycle. Studies have found that the stock market rises from lows three to six months ahead of the lowest point in the business cycle. As such, we may have already seen the bottom of the coronavirus-led recession.

If that is the case, all investors needed was a confirmation of a possible end of the health crisis. That confirmation, or at least an incipient sign of it, came last Monday with the COVID-19 vaccine news.

Are the Tables Turning?

Why would investors decide to invest in emerging markets in the first place? The answer comes from increased volatility. Yes, higher risks exist – but also higher rewards.

Moreover, diversification is key in protecting a portfolio. Emerging markets bring the potential of participating more to the upside in an expansionary phase of the business cycle. On the other hand, the risk of being invested in emerging markets during a recession is significant.

Take the Turkish Lira (TRY), for example. It bounced 9% after the head of the central bank was replaced. However, in the grand scheme of things, a look at the five-year chart against the U.S. dollar shows that this is just a blip.

All in all, for more than four years now, emerging markets currencies look cheap. In the last two-and-a-half decades, only two times, they looked so cheap when using standard deviation. Moreover, each time when they looked so cheap, a strong bounce followed.

Time to go long or the worse is yet to come?

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