Investors are fleeing emerging-market stocks at the fastest pace since 2015 as trade-war fears escalate

• Emerging-market equities saw their largest outflow since 2015 this week as US-China trade tensions spiked, and as concerns over global growth mounted.
• Latin America is the most exposed region because it trades heavily with China, according to analysts at Bank of America Merrill Lynch and JPMorgan.
• Read more on Markets Insider.

Signs of stress were plentiful in emerging markets this week as escalating trade tensions between the US and China stoked fears of slowing global growth.

EM equities saw $6.2 billion of outflows, the biggest weekly total since 2015, according to data compiled by Bank of America Merrill Lynch. That coincided with a roughly 2% decline in the MSCI Emerging Market Index.

The flight from emerging markets came as trade tensions between the US and China increased and morphed into fear of a global currency war. On Monday, China let the value of the yuan slide as a retaliation of the threat of extra tariffs from President Trump, sending riskier assets such as US and EM equities down roughly 3%.

Since, markets have whiplashed after a trio of central banks issued rate cuts, spurring fears that global growth is slowing and making risky assets look even less attractive.

Going forward, industry watchers expect trade tensions to continue to weigh on the global economy. This will drag on emerging-market countries, especially those that have less room to leverage monetary and fiscal policy to cushion the shock, wrote Claudio Irigoyen and David Huaner of Bank of America Merrill Lynch in a note Friday.

"We expect uncertainty to remain high in August as the next chapter of the US-China trade war unfolds," they said.

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The performance this week is a shift from earlier in the year, when emerging-market stocks showed signs of improvement following the last time that trade war news dragged them lower in May. In June, signs of trade progress and a positive economic backdrop sent the MSCI Emerging Markets gauge rising again.

"If you also look at times when it feels that trade may be resolved or trade issues may be improved you notice how sharply emerging markets rally," Rashmi Gupta, a money manager at JPMorgan Chase Bank in New York, told Markets Insider in a recent interview.

At the end of July, emerging-market assets were up about 7% since January, though still underperforming developed markets over the same time frame. The rally ended when - following the US Federal Reserve's quarter-point cut in July - Chairman Jerome Powell signaled it wasn't the start of a prolonged easing cycle. That hawkishness was viewed as a headwind to further accommodation and global growth stimulus.

A high degree of Latin American exposure

Within emerging markets, Latin American countries are particularly exposed to trade news, according to Bank of America and JPMorgan. This is because the region has the most countries that export commodities to China.

Since 2001, annual trade between China and Latin America has increased 18 times, eclipsing exchange between the US and the region, according to Franco Uccelli, head of investment strategy for Latin America at JPMorgan Private Bank. It's become the main trading partner for South America and the second largest in Latin America, Uccelli said.

"That generates some concern," Uccelli told Markets Insider. "You need your main trading partner to be strong."

The worry is if the escalating trade tensions between the US weaken the economy in China, demand from the region will decrease, meaning that commodity exports such as Brazil, Peru, and Chile would suffer as they rely heavily on strong demand from China, Uccelli said. Other vulnerable countries include South Africa, Indonesia, and Turkey, wrote Bank of America.

The volatility in emerging markets is likely to continue, and even if the US and China reach a deal on trade, it should be regarded with some skepticism by investors, Morley Campbell, CIO at Continuous Capital - a part of Resolute Investment Managers - told Markets Insider.

Still, Campbell said that investors shouldn't overlook emerging-markets in the long-term, even though there's short-term volatility risks.

That's because valuations are still a big discount compared to other equities, many EM countries pay cash dividends, and the class is still poised for blockbuster growth going forward.

It comes down to getting valuations right, he said.

"Don't bet the ranch," he said. "Maintain a modest but consistent allocation over time."