Brazil Shakeup Sounds Warning on Crowded Emerging-Market Trades

Brazil’s market selloff has delivered a stark warning to emerging-market investors: crowded trades can unravel with alarming speed.

Popular bets ranging from Asian artificial intelligence-linked stocks to Hungarian bonds and the South African rand are facing fresh scrutiny after an election shock sent Brazilian shares and the real tumbling, exposing how one-sided positioning can amplify market reversals.

Allspring Global Investments sees overcrowded AI stocks as vulnerable to disappointment around Anthropic’s IPO, while Invesco is wary of risks tied to hyperscalers’ AI spending. Societe Generale SA flags emerging-market credit due to tight spreads, while Citigroup Inc. is pointing to concentrated buy-side positions in Hungarian rates and the forint, and local-currency frontier debt.

“A hawkish Federal Reserve or material escalation in geopolitical conflicts could place pressure on EM positions that have been investor favorites,” said Brendan McKenna, emerging-market strategist at Societe Generale in New York.

Signs of stretched positioning are cropping up across markets. Leveraged funds’ net-long position in the South African rand is near a two-year high, while foreign holdings of Hungarian bonds have climbed to a record. A Bank of America Corp. survey last month showed global semiconductor stocks as the most crowded trade.

The realsuffered its worst day since 1999 on Monday, while Brazil’s stock market hit a trading halt just minutes after opening. The benchmark index ended down almost 14%, with some stocks losing over 50%, as the unexpected re-election of leftist President Luiz Inácio Lula da Silva upended markets largely positioned for a win for right-wing candidate Flávio Bolsonaro.

Before the result, the real was the second-best-performing EM currency year-to-date behind the Colombian peso, as Brazil’s high interest rates attracted yield-seeking foreign funds, while stronger commodity prices provided additional support.

“You see as an evidence, the size of the damage that we are seeing these days on the surprise re-election of Lula,” Julio Callegari, chief investment officer of Asia fixed income at JPMorgan Asset Management, said in an interview in Singapore on Tuesday. “It’s a big Value-at-Risk shock, right? I would say that the market is not even totally clean yet.”

‘Squeezed Into’

SocGen’s McKenna pointed to credit as one of the most crowded trades. “Spreads are very tight,” especially in the context of elevated inflation, central bank tightening and geopolitical uncertainty, he said.

The yield premium of Bloomberg’s emerging-market sovereign bond index over comparable US Treasuries has narrowed to 210 basis points, more than 100 basis points below its five-year average of 315.

Meanwhile, the turmoil in Brazil has also drawn renewed attention to Hungary, among the standout performers in emerging markets this year. Local assets have rallied as a change in government fueled hopes of progress toward euro adoption. Foreign holdings of Hungarian Treasury bonds and bills hit a record 11.1 trillion forints ($34 billion) last month, underscoring how heavily investors have piled into the debt.

Similarly, leveraged funds and asset managers hold about $688 million of net long positions in the South African rand, near the highest since late 2024, Commodity Futures Trading Commission data compiled by Bloomberg show. The rand has been among this year’s popular carry trades — a strategy that involves borrowing in a low-interest-rate currency to invest in higher-yielding assets.

“Given the rise in risky asset volatility (especially on the rates side), the buy-side has been squeezed into a few similar trades,” Citi strategists wrote in a recent note. “If any of those residual idiosyncratic trades disappoint, we could see an acceleration on this tendency to take risk off the table,” they added.

In frontier markets too, trades that have funds are coming under scrutiny. Carol Lye, a fund manager at Brandywine Global Investment Management in Singapore, pointed to crowded positioning in short-term local-currency frontier bills from Egypt, Turkey, Nigeria and Kazakhstan.

If global rates rise a lot more, or equity markets start to sell off, you will “see a lot of rotational money coming out of these trades,” she said. A JPMorgan gauge tracking the performance of debt issued by frontier nations has corrected about 3% since a record high in early September.

To be sure, political upheaval and sudden market reversals are familiar risks for EM investors. And despite concerns about crowded positioning, many of this year’s popular trades continue to enjoy support from factors such as attractive yields and strong corporate earnings.

Meanwhile, one crowded EM trade that has begun to show cracks is AI-linked equities in Asia. Tech stocks have sold off as earnings from some US megacaps disappointed, and concerns mounted over whether massive spending on AI can translate into sustainable profits.

“Hyperscalers’ AI spending remains a key indicator to monitor,” said William Yuen, investment director at Invesco. “Any meaningful slowdown could weaken the growth outlook for Asian technology supply-chain companies.”

A Bloomberg gauge of semiconductor-linked stocks in the region, which sits at the heart of the AI hardware supply chain, is down almost 25% since a June peak.

“Within EM equities, AI-related stocks and the momentum factor remain relatively crowded trades,” said Gary Tan, portfolio manager at Allspring Global. “A lackluster Anthropic IPO process could challenge sentiment.”

What to Watch

Investors will monitor inflation data from a slew of economies, including South Korea, Indonesia, the Philippines, Thailand, Taiwan, Turkey, the Czech Republic and Chile, to gauge price pressuresIndonesia will also release third quarter GDP dataCentral banks in Malaysia, Poland, Brazil, the Czech Republic and Mexico are also scheduled to announce interest-rate decisions in the coming week

参与讨论