We’ve talked quite a bit over the past two weeks about the prospects for an imminent reversal of fortune for all things emerging markets.
We’ve also talked more than we would ideally like to about the whole “sell in May” urban legend.
You can check out some of the relevant posts here:
- Sell In May? One Strategist Looked At The Evidence
- Don’t Look Now, But Something Cracked On Tuesday
- It’s “Make-Or-Break Time” And We Could See “A Painful Cleanout”
On Sunday, we wanted to kind of fuse these two themes (May seasonality and an emerging market correction).
A couple of days ago, Bloomberg was out with a piece called “Curious Curse of May: Emerging-Market Currency Bulls Beware.” To be sure, the notion that EMFX is due for a pullback certainly isn’t new. As you can see, EM assets in general have had a pretty damn good run:
But as it turns out, May is an especially bad month to be long EMFX.
“Blame dividend payments, weddings in India, or simply plain profit-taking [but] developing-nation currencies could be in for a rough month in May, if history is any guide,” Bloomberg wrote on Thursday, in the piece linked above, adding that “the MSCI Emerging Markets Currency Index has fallen in May in the six of the past seven years, a seasonal quirk that’s prompted Citigroup Inc. and Credit Suisse Group AG to warn investors that the gauge’s five-month winning streak may be coming to an end.”
As Bloomberg goes on to note, there are several possible explanations for this, including “dividend payments to offshore investors in Thai and Indonesia companies [and] a seasonal increase in gold purchases in May [that] seems to drive the rupee down.”
So given that, just what currencies are most vulnerable? And relatedly, what assets generally benefit from positive May seasonality? We’re glad you asked because as it turns out, Citi took a look. Find excerpts below from a note dated Thursday…
IMF may mark peak of bullishness… Also, we returned from the IMF meetings in DC last week with a sense of bullishness among investors, who were more inclined to add rather than reduce EM risk. We wrote at the time that we could see the peak of EM bullishness after the meetings, boosted by the market positive outcome of the French election.
…before May seasonality takes over. Of course, robust inflows and positive sentiment don’t necessarily cause weakness. But we would be a little more cautious and not overstay our welcome with seasonality being a headwind. We define seasonality as the difference between the median return for a given month and the average of the median returns of all 12 months of the year. To get a sense of likelihood and not just the magnitude, we also calculate the probability of a positive change across the sample period. We first look at macro drivers for EM, namely S&P 500, commodities, USD, and EUR. Figure 7 shows that seasonality is favorable for the USD, lackluster for the S&P 500, and negative for commodities. The strongest impact may be felt by the EUR (which makes up most of DXY) with the largest loss and highest probability of a loss. US yields also don’t help. 10-year US Treasury yields have a small but positive seasonal (+4.5bp). (Figure 9) It’s no surprise that this macro backdrop, if it materializes, would bring about a breather in EM after a strong run since the start of the year.
BRL, ZAR, CLP with negative seasonality. Figure 8 shows that seasonality for all major EM currencies is negative (i.e., positive for USD and EUR pairs). In terms of magnitude the impact is most pronounced in BRL, followed by ZAR. CLP and INR should not be overlooked either – relative to the other months of the year, CLP has underperformed in May more than 80% of the time, followed by INR at 76%.
High yielders at risk in rates space. Seasonality isn’t favorable for bond yields either. Figure 9 shows that Turkey and South Africa stand out. Brazil also scores high in terms of magnitude but the probability is less than 50%. This suggests that some caution may be warranted in the high yielding curves in EM, especially since they appear to have been popular destinations for much of the inflows year to date.