EM Blood In The Streets

“Buy when there’s blood in the streets” is perhaps the oldest capital markets aphorism out there and widely attributed to Nathan Rothschild, an 18th century British banker. The second (and better) part of the quote usually gets left out: “even when it is your own”. Anyone who has ever traded stocks for a living will understand the sentiment, and it also sounds classier than our generation’s “Instead of crying, you should be buying”.

But how do you know the point of maximum market pain? No amount of fundamental analysis will yield a useful answer when markets go pear-shaped. Cheap assets just get cheaper during steep declines. To measure “Blood in the streets” you need an emotion-based metric.

That’s where options-based measures of implied volatility comes in handy, and today we want to take a whirlwind tour of emerging markets to see if the recent damage there makes this asset class worth a Rothschild-ian trade. This is the same math that underpins the CBOE VIX Index. When that spikes suddenly and to above-average levels, you know fear has crept into US equity markets. And with that, opportunity.

Here’s what the “VIX of” emerging market stocks and bonds has to say, using data from the options pricing for EEM and EMB, the iShares ETFs that track these asset classes’ most widely held indices:

• We start by looking at prices as of Monday’s close, consciously ignoring today’s snap-back rally. We assume there’s more trouble brewing and from recent client conversations we suspect most readers will agree.

• The “VIX of” EEM (MSCI Emerging Market equities) was just 18.4 at Monday’sclose. This is well below the 2018 peak of 31.7 (February) and even the early June highs of 20.0. Actual 30-day volatility mirrors this, which we would expect. Options market reads on future volatility usually track actual price churn rather than being purely forward-looking.

• The “VIX of” EMB (JPMorgan EM Bond Index) is much closer to its 2018 highs, at 8.4 versus 10.0 (also set back in February). Thirty day historical volatility is actually at 1-year highs, a promising sign.

Why do emerging market bonds look so much more washed out than EM stocks? Because the indices here measure two very different things:

• The largest weightings in the EM bond index are to: Mexico (6%), Indonesia (5%), Russia (4%), and China (4%), with Brazil/Columbia/Turkey/Philippines all at 4%.

• Conversely, the EM equity index is much more concentrated in Asia: China (29%), South Korea (14%), Taiwan (12%) and India (8%) are 63% of the total.

• In simple terms, that makes EM bonds a call on lessening currency crisis worries, while EM stocks are leveraged to global trade/tariff concerns. Big difference.

So are those highs in the “VIX of” EM bonds a green light to buy them for a trade? Our answer is “Not yet”. First of all, we’re not yet back down to 5 year lows (another 3% away), and with the Federal Reserve still bent on raising interest rates the fundamental picture isn’t good. Also, we don’t yet see a resolution to the Turkish currency/political crisis. There will be a time to buy when that starts to develop.

Bottom line: “Buy when there’s blood in the streets” is a fine saying but absent a clearer sign that the worst is past it does not yet apply to EM stocks or bonds. And we’d strongly prefer that the “even if its your own” bit never applies to you. Or us.