Streaks have snapped: The calm in emerging markets suddenly broke

After months of inflows in emerging-market stocks and debt, the streaks have snapped

Investors yanked money out of emerging-market funds for the first time in months, a sign of trouble in what has been a sturdy corner of the market for much of the year.

Emerging-market debt funds and stock funds both had outflows for the week ended Aug. 16, according to fund-data tracker EPFR Global, as many global investors turned more cautious on risk. Before that, money had poured into emerging-market stocks for 21 straight weeks and into emerging-market debt funds for 28 consecutive weeks.

The outflows came as threats of nuclear warfare ramped up between the U.S. and North Korea. Concerns over more political instability in the U.S. following President Donald Trump’s response to violence at a white-nationalist rally in Charlottesville, Va., further fueled investor trepidation.

While investors acknowledge the recent bumps, many say it isn’t time to call an end to the rally in emerging-market stocks and bonds. Instead, they say, the outflows are indicative of the typical volatility in emerging markets. Rising global tensions and political turmoil in the U.S. also had sparked a pullback in U.S. markets, with the Dow Jones Industrial Average on Thursday notching its biggest decline in three months.

A net $1.6 billion fled emerging-market equities in the week ended last Wednesday, the largest outflow of the year, according to EPFR Global. It marked the first time investors pulled money from those funds since mid-March.

Investors also pulled cash out of emerging-market debt funds, snapping the longest streak of consecutive weekly inflows since 2013. And $2.3 billion poured out of high-yield-bond funds, the most in almost six months.

Cracks were forming in emerging markets last month as major central banks started to discuss winding down years of stimulus. The latest political turmoil added to the concerns.

One worry, according to JC Sambor, deputy head of emerging-market fixed income at BNP Paribas Asset Management, is that if Treasury yields rise, U.S. government bonds would become more attractive. That could trigger outflows from U.S. dollar-denominated emerging-market debt.

“The market on the hard-currency side is very complacent about Treasury risk,” Mr. Sambor said. He said that while he has become more cautious, he continues to like local-currency government bonds in India, Malaysia and Indonesia.

“We think Asia is on very sound footing,” he said, describing growth as improving but “not too hot and not too cold.”

Asian stock and bond markets have been some of the biggest beneficiaries of the return to risk this year. Now, there are signs that those markets are beginning to cool. Foreigners pulled money out of Asian emerging-market stocks in July for the first time this year, selling a net $800 million in shares in the region, excluding China, according to ANZ.

Foreign investors continued to buy Asian emerging-market debt last month, though their net purchases of $4.7 billion, excluding China, marked the smallest monthly amount since March.

“I’m encouraged by this increase in risk aversion,” said Stephen Corry, head of investment strategy, Asia Pacific, at LGT Bank in Hong Kong, which has about $150 billion in assets under management.

Mr. Corry said he is positive on both emerging-market equities and debt. “Several indicators were getting frothy on a short-term basis,” he said. “But we keep telling clients if you see weakness, buy more.”

And even with the recent outflows, emerging markets have had a strong year, consistently defying events originally seen as stumbling blocks.

Money has a history of flowing out of emerging markets when the U.S. Federal Reserve is tightening policy. A recent example was in 2013 during the “taper tantrum,” when investors dumped emerging markets as the Fed signaled it was getting closer to removing cheap post-financial-crisis cash.The Fed has raised interest rates four times since late 2015, including twice this year. But the tightening cycle has been slow and predictable, and hasn’t spooked investors.

“We remain relatively optimistic about the outlook for emerging-market capital flows,” the Institute of International Finance wrote in a note late last week. “However, the pace of emerging-market inflows…does highlight the risk of periodic setbacks.”