Emerging markets have taken a beating this year as higher interest rates from the Federal Reserve, a strong dollar and US president Donald Trump's tariffs tit-for-tat with China have weighed on investor sentiment towards emerging markets.
But it took Turkey's currency collapse to push emerging markets into official bear market territory.
Yesterday's fall for the MSCI Emerging Markets index was its heaviest in six months and means the sector has now slumped 20% from its peak.
It was a further sign of the spill-over from Turkey's deepening economic problems, despite its lira currency recovering some ground from a plunge in value that accelerated dramatically on Friday.
Having fallen by more than 23% against the greenback in the space of three days, the lira has since rallied by more than 18% since Tuesday, although it remains 35% down since the turn of the year.
'The irony is that whilst Turkey had a good 36 hours, the rest of global markets seem to be suffering from a delayed contagion reaction yesterday,' said Deutsche Bank's Jim Reid.
Strong dollar weighs
The catalyst for yesterday's heavy emerging markets sell-off was continued dollar strength. The greenback has risen 8% against a basket of global currencies over the last three months, and 13% against the pound, a rally that has accelerated over the last week.
Turkey's currency woes have prompted investors to flee riskier currencies to the perceived safe haven status of the dollar. Over the last six trading trading days, the Argentinian peso has lost 8% against the dollar while the South African rand is down 7.8%.
A strong dollar tends to hurt emerging markets, as it renders their debt held in the US currency more expensive.
'We recognize that a backdrop of rising US interest rates and a strengthening US dollar — while reflective of a strong US economy — can impact emerging markets,' he said.
'While a strong US economy is good news for the global economy, including emerging markets, higher interest rates can make it costly for borrowers to service their external debt.
'So, local currencies can — and have — come into pressure as servicing dollar-denominated debt becomes more difficult. Capital flows have reversed out of what’s perceived to be “riskier” markets.'
But Sehgal argued the fundamentals of emerging markets remained strong, and that investors had overreacted, just as they did as the sector came under pressure between 2013 and 2015 as the US reined in quantitative easing.
'While it’s true that some economies were vulnerable, in some cases, the markets were pricing in crises-type levels. The currencies became undervalued, and when a crisis didn’t occur, we saw a rebound.'
Debt fears overplayed
Sehgal argued that fears over the impact of the strong dollar were overplayed, given 'the preponderance of debt stock in emerging markets is now actually in local currency rather than US dollars', adding that current account deficits were vastly improved since 2013's 'taper tantrum'.
Alain-Nsiona Defise, head of emerging corporates at Pictet Asset Management, agreed.
'Emerging markets’ current account surplus has grown from 0.1% to 0.8% of gross domestic product (GDP) over that time,' he said.
'Even among emerging countries with deficits, the gap has narrowed to 1.7% of GDP compared to almost 4% during the taper tantrum of 2013.'
For all that Turkey's troubles have further soured sentiment towards emerging markets, Defise said the country was 'far from representative' of the sector.
'There is always the temptation among investors to lump emerging nations together and dump their currencies and assets wholesale at the first signs of trouble,' he said.
'But dig a little deeper and it’s clear that the country is an emerging market outlier.'
For now, though, Turkey's small size, representing less than 1% of the emerging markets index, and limited trade links to the rest of the sector, hasn't stopped the broader sell-off.
'Limited direct contagion from Turkey is little comfort,' said Jon Harrison, strategist at TS Lombard.
'The collapse of Turkish markets raises investors' fears even when there are few direct linkages, and could certainly be the one crisis too many that prompts some to take a decision to scale back exposure — coming at a time when broad-based emerging markets risk-off is already taking shape.'