Since the “shrink panic” in 2013, emerging market stocks have lagged the developed economies the most because investors fear that global tightening of monetary policy will trigger investors to flee the asset class.

In U.S. dollars, MSCI’s emerging market benchmark index is basically flat in 2021, including dividend payments. The mediocre performance is in stark contrast to the global developed market stock indicator of the index provider, which has achieved a return of more than 20% so far this year, thanks to the rise in US and European stock markets.

Emerging market bonds have also underperformed, with falling prices offsetting the relatively lucrative interest payments investors receive from holding bonds. The JPMorgan Chase index, which tracks bonds issued in local currencies, has fallen 8.1% in U.S. dollars so far this year. Indicators of similar bonds issued in major developed market currencies fell 1.5%.

Analysts warned that market conditions may deteriorate further after the Fed announced this week that it plans to start controlling its coronavirus crisis stimulus measures. In 2013, the U.S. Central Bank’s decision to start loosening its economic support measures triggered a massive sell-off of assets in emerging markets as part of an extensive restructuring of financial markets known as the “shrink panic”.

“We are facing a slowdown in global economic growth and rising inflation, and central banks are forced to take action. Overall, this should be super negative for emerging markets,” said Minna Kuusisto, head of global macro research at Danske Bank Helsinki.

Other risks include a more-than-expected slowdown in China’s economy — the main driver of growth in emerging markets in the past two decades — and, for many poor countries, severe delays in coronavirus vaccination, jeopardizing recovery from the pandemic.

Despite poor returns this year and risks in the future, investors continue to invest funds in emerging market assets.

After a panic sell-off at the beginning of the pandemic in March last year, foreign investors withdrew US$90 billion from emerging market bonds and stocks. However, for the next 19 months, except for one month, foreign investors have flowed to emerging market assets. Net portfolio inflows have always been positive. According to data from the industry association International Finance Association, nearly 790 billion U.S. dollars of capital returned, including 25 billion U.S. dollars in October.

One reason is that the Federal Reserve and other central banks of advanced economies injected trillions of dollars into global financial markets during the pandemic. Many governments in emerging markets seized the opportunity to issue new bonds at lower interest rates than normally offered. Due to the lack of income elsewhere and the attractive valuation of assets compared with advanced economies, foreign investors have poured in.

But this is not enough to push up prices. Analysts said that one factor that frustrated them is the threat of rising global inflation, which has pushed up bond yields in developed markets.

“Prices reflect expectations for the future,” said David Hauner, emerging market strategist and economist at Bank of America. “Global interest rates have soared, which has weakened prices, even though investors have tried again and again to buy on dips.”

Many policymakers in emerging markets began tightening policies earlier this year. In the face of accelerating consumer price inflation, some people have been actively raising interest rates.

This in itself hinders growth. But emerging economies are particularly troubled because one of the factors driving inflation is rising energy prices, partly because of pandemic-related disruptions. Some countries such as Russia will certainly benefit, but in a world where growth is slowing, many emerging markets will be hurt by rising fuel prices.

Kuusisto lists India, Turkey, and Egypt as particularly vulnerable countries. But she warned that most emerging countries in Europe, Asia and Latin America will suffer losses in the coming months as energy further drags down economic growth.

“The market is concerned about inflation, not stagnant growth,” she said. “I’m not sure if they actually noticed [to rising energy prices] And the impact on emerging markets. “

This makes emerging market stocks and bonds particularly vulnerable to rising interest rates in the United States and other advanced economies, which will reduce the attractiveness of risky assets.

Many analysts said that it is unlikely to replicate the panic, because this time, investors will not be surprised. They also pointed out that many emerging economies have built strong buffers in the form of foreign exchange reserves and more resilient debt positions, reducing their reliance on foreign currency debt or short-term borrowing.

But the pandemic has challenged some of these defenses. The trade balance has been hit by rising commodity prices, and debt is piled up like mountains, usually with short maturities, and the share of foreign investors’ holdings continues to increase, making many countries vulnerable to divestments.

Kuusisto of Danske Bank worries that the flow of funds to emerging market assets may not last long: “The risks are too much,” she said.