Emerging market hotspots to watch

Volatility in global markets has been fueled by concerns about Turkey—and has investors assessing other potential trouble zones in emerging markets.

“As the U.S. economy hums along nicely, other economies are not faring so well,” says TD senior economist Fotios Raptis in a weekly economics report. He compares Turkey’s situation to that of Argentina last quarter.

At that time, “concerns about the financial outlook for Argentina drove a dramatic depreciation in the peso, forcing the central bank to raise domestic policy interest rates to 40% in an attempt to slow capital outflows,” he says in the report. “Like Argentina, Turkey depends heavily on foreign capital to finance domestic spending.”

Though Turkey’s economy is too small to trigger a broader global crisis, “contagion to other economies can still occur through confidence and sentiment channels,” says the report. Further bouts of volatility are likely as “emerging market economies with large imbalances are targeted one-by-one by increasingly discerning investors.”

Brazil and South Africa are potential candidates.

Both countries struggle with large budget and current account deficits, plus have difficulties implementing structural reforms, says a BMO weekly financial digest.

In Brazil, presidential and congressional elections in October could complicate policy if populism takes hold. If the next government is unable to push through needed fiscal reforms—specifically, overhauling the costly social security system—look for more pronounced volatility in Brazil’s financial markets, says the BMO report.

Reforms are also an issue for South Africa, including fiscal consolidation, enhancing governance at state-owned enterprises and tackling corruption. An additional issue is that the ruling African National Congress party has promised to explore land redistribution. Investors could become unsettled if reform drive stalls or reverses course, says the report.

On a brighter note, Edward Jones commentary puts recent market volatility in a cyclical perspective: “That Turkey’s domestic issues have roiled global stocks suggests that markets are still responding to potential risks (big or small). This can be viewed somewhat positively in that market peaks are often characterized by a sense of euphoria where risks are ignored in favor of surging market gains.”

Read the full reports from TD and BMO, and the Edward Jones commentary.

Also read:

Investing tips as bull market becomes longest in history

Why buy-and-hold investors should be cautious late cycle

The story behind emerging market outflows