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Why emerging markets could sell off again

Monday, 5 Aug 2013 | 10:14 AM ET
Stringer | AFP | Getty Images

The risk that the Federal Reserve starts winding down its asset purchases sooner rather than later could spark another emerging market (EM) sell-off, analysts told CNBC, with some countries better placed to deal with higher real U.S. interest rates than others.

EM funds made a comeback in July - posting gains for the first time since March, according to Morningstar research – after taking a battering on uncertainty surrounding the end of the Federal Reserve's massive stimulus program. .

While Friday's disappointing U.S jobs data helped ease fears of an imminent end to asset purchases, Luis Costa, emerging markets strategist at Citi, said that the possibility the Fed might start the tapering process after its next meeting could cause another EM sell-off.

"We are still seeing outflows in EM funds, albeit at a decelerated pace to what we saw 2 or 3 months ago," Costa told CNBC on Monday. "While I do believe the tapering call in September is definitely questionable, we do know that we are talking about a scenario where the Fed are willing to change QE [quantitative easing] dynamics over the next 6 months."

(Read more: US equity funds see highest-ever inflows in July)

Is now the time to get into emerging markets?
Luis Costa, emerging market debt strategist at Citi, tells CNBC that higher US rates will challenge capital flows in emerging markets.

He added: "I am not an all-time seller of EM, but we do believe there is value in the front-end curves, given the dovish central bank bias. If you look at the long-end of the curve you have to be careful, because that is where we expect a lot more reassessment to go on."

Costa said the countries most reliant on borrowing to balance their current accounts would be most exposed to tapering, and highlighted Turkey and Brazil as a "case in point".

Slim Feriani , CEO of Advance Emerging Capital, agreed that some nations would deal better with higher U.S. rates than others. He said the less vulnerable countries are the "savers" or those with a current account surplus, such as South Korea or Russia.

"Contrast that to the likes of South Africa, Brazil and Turkey, with current account deficits — they will find it much more difficult if the cost of capital increases, certainly it wouldn't be great news for them," Feriani said.

(Read more: China data may catch bears on the wrong foot)

Stock picking is the way to go in emerging markets: CEO
Slim Feriani, chief executive officer at Advance Emerging Capital, tells CNBC that stock picking remains the way to go for emerging market, but he likes Turkey, Thailand and Indonesia for the domestic story.

Despite these risks, Feriani said valuations were close to bottoming out for emerging market stocks - both in absolute terms, as well as relative to their own history and to developed markets.

"The stars have lined up the wrong way for the last 12-18 months for EM, but I go back to valuations and a lot has been priced in, so I do think we should be closer to the bottom," he said.

"After this period of relative weakness, with emerging equities trading, in aggregate, at a 35 percent discount to the rest of the world on a price-to-earnings basis and a 30 percent discount on a price to book basis."

(Read more: Defending currencies? More like digging a hole)

Feriani identified Russia as his pick on a macro basis. "Everything has a price and U.S. rates won't be as bad for them as others," he added.

By CNBC's Jenny Cosgrave: Follow her on Twitter @jenny_cosgrave

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