NEW YORK: The Federal Reserve’s (Fed) most aggressive policy tightening in two decades is sucking emerging markets (EMs) into a “sell everything” slump, not even sparing assets that should do well when interest rates rise.

       Take value stocks. Shares of mature companies with high dividends and cheap valuations are finding a bid in the United States and Europe, where investors are switching to them from more expensive equities in fast-expanding sectors like technology.

       But this so-called growth-to-value rotation is failing to happen in developing nations, where both types of stocks are falling in tandem.

       The contrast suggests EMs may extend their underperformance against US stocks into a fifth straight year.

       While past hiking cycles have coincided with rallies in developing nations, this time may be more challenging because the Fed hasn’t tempered its tightening with accommodative rhetoric like it did in, say, 2016.

       In fact, liquidity is drying up around the world, leaving investors with little appetite for even bargain stocks.

       “This goes back to the basic EM investment philosophy: You generally don’t want to be long EM until the Fed’s basically done,” said Nick Colas, co-founder of DataTrek Research.

       Value stocks are typically favoured at the start of tightening cycles because their superior earnings and dividend yields help investors to cushion the impact of higher borrowing costs and the consequent reassessment of equity valuations.

       But now, that connection is broken. The MSCI EM Value Index has tumbled 13% in the past three months, better than a 20% decline in the corresponding gauge for growth stocks.

       History tells a different story. During the 2004-2007 Fed tightening cycle, the value stocks gauge jumped 216%. In the two years through January 2018, its 61% rally coincided with Fed hikes.

       A key factor behind the indiscriminate bearishness now is the dollar’s strength. The greenback imposes the same currency risk on all securities, irrespective of relative valuations. That leaves traders little room to distinguish between them.

       Top components of the value-stock universe, commodities and finance, have begun to wobble. The Bloomberg Commodity Index has been trending lower since an April 18 peak, while oil is down 13% since early March.

       Traders are unwinding their bets on commodity-dependent currencies, bonds and stocks, leading to a 6% drop in capital flows into the developing world over the past five weeks.

       “EM flows tend to follow the strength of the dollar,” Art Hogan, chief market strategist at National Securities, wrote in an email. “That has been moving higher and putting a major dent into fund flows.”

       Fresh outbreaks of Covid in China – and the nation’s stringent policy to contain them – have raised the spectre of faster inflation and slowing growth in the world’s second-biggest economy.

       That may undermine demand for everything from raw materials to bank loans, dragging down corporate performance.

       “Headwinds prevail as the sharp rise in US Treasury yields and the earnings downgrades in China are taking money and risk appetite away from emerging economies,” said Leonardo Pellandini, equity strategist at Julius Baer.

       “Margin pressure will continue and high inflation will make it hard to pass through costs to the consumer, while global growth guidance is significantly lower.” — Bloomberg