Brace for a 10% Correction in Emerging Markets

Spreading unrest in the Middle East has lead to a sell-off in Asian markets over the past week as investors look to exit risk trades and lock in profits.

Traders sit in front of their screens at the stock exchange in Frankfurt/Munich, western Germany.
Martin Oeser | AFP | Getty Images
Traders sit in front of their screens at the stock exchange in Frankfurt/Munich, western Germany.

This overall downside momentum is expected to continue, with some market watchers forecasting a significant correction to take place across emerging markets in Asia in the first-half.

“Emerging market equities are going to head lower. We are currently at 1,100 on the (MSCI) EM index. I think it will go below 990, a very typical EM correction,” Adrian Mowat, chief Asian & emerging markets equity strategist at J.P. Morgan told CNBC on Tuesday.

The MSCI Emerging Market Index has slumped 3.9 percent this year, while the MSCI World Index, which tracks 24 developed markets, has climbed 4.3 percent. Expectations of higher inflation and monetary policy tightening are pushing funds out of the region in search for better growth opportunities.

However, Mowat says that investors can hedge against the downside risk, highlighting the options market as the most efficient way to do so.

He recommends buying put options on the South Korea’s benchmark KOSPI index, which he believes is set to decline in the coming months. A put option gives the owner the right to sell an underlying security at a particular price within a set time frame.

“[South Korea] is a country where food inflation is twice as high as it was in 2008, domestic demand is quite weak…because household income growth is relatively modest and people are spending more money on food and energy,” he explained. “So I think earnings in Korea are quite vulnerable.”

After the market correction takes place, however, Mowat advises investors look at buying back into the ASEAN region, where he believes inflation worries are “overstated”.

According to J.P. Morgan, ASEAN nations will be the main beneficiaries of rising labor costs in China as companies look to shift their production base into more cost-effective locations.

Click here to watch Adrian Mowat's full interview.