Recent events have put pressure on emerging market assets. Our sense is these stresses are idiosyncratic to particular emerging economies rather than systemic.
Financial markets seem programmed to believe that a rising US dollar and rising interest rates are bad for emerging economies. Remember the ‘taper tantrums’ in 2013 and the anointing of five key emerging economies (India, Indonesia, Turkey, South Africa and Brazil) as the ‘fragile five’?
A similar dynamic is playing out in 2018 as emerging markets are being challenged by a stronger US dollar, higher interest rates and a significant rise in oil prices. Higher oil prices are good for emerging economies on average, but bad for the oil importers.
Add to that considerable uncertainty with respect to trade policy, particularly in the US, and the scene appears to set for a challenging period ahead. Debt levels are also higher and this is not just an emerging market phenomenon.
But this is not 2013. This year, conditions are generally more positive across the emerging market complex than they were five years ago. On average GDP growth is stronger, inflation is lower and current account balances are in better shape.
However, it is not a universally ‘better’ story. The current environment has been most challenging for Argentina and Turkey, both of which are experiencing a trend deterioration in their external imbalances, making the required offsetting capital inflows vulnerable to negative shifts in sentiment. Indeed, both currencies have suffered considerable weakness this year.
The reality is structural weaknesses in individual economies will still be punished, and rightly so. The Argentine government of Mauricio Macri made a bold start in 2015, aiming for a gradual reduction in the primary budget deficit and an ambitious target of bringing inflation down to a single digit rate in three years. More recently, the Macri administration has pinned its political hopes to a large infrastructure programme.
But just last week Argentina was forced to negotiate a US$50 billion standby facility with the IMF, which brought with it conditions on the fiscal deficit, inflation and the exchange rate. The most notable part of the agreement is that the central bank is now forbidden to finance the fiscal deficit. This had been a key source of recent market consternation.
Turkey has come under pressure in the lead up to Presidential elections later this month. The Turkish lira has depreciated significantly, inflation has spiked higher and the political uncertainty brings with it uncertainty about the future operation of monetary policy.
As a whole, the emerging market complex is in better shape than it was in 2013. While equity markets are likely to be challenged to repeat last year’s outstanding 31% average gain and will likely remain volatile in the immediate future, bear in mind that the main emerging market share index is still yet to fully regain its 2007 (pre-Global Financial Crisis) highs and is not in overvalued territory.
As ever, three words sum up the best advice for emerging market investment: “selectivity is key”. Despite positive demographics, a growing middle class and a proliferation of investment vehicles that allow savers around the world to finance emerging country growth, many countries still face structural challenges of varying magnitudes. The key message to the politicians is those structural challenges need immediate attention. Lack of attention will be punished accordingly.
This blog post has been prepared to provide general information and does not constitute 'financial advice' for the purposes of the Financial Advisors Act 2008 (Act). An individual investor should, before making any investment decisions, consider the information available in the relevant Product Disclosure Statement and seek professional advice. While every care has been taken in the preparation of this document, AMP Capital Investors (New Zealand) Limited and the AMP Group (together, 'AMP') make no guarantee that the information supplied is accurate, complete or timely and do not make any warranties or representations in respect of results gained from its use. The information is not intended to infer that current or past returns are indicative of future returns. The views expressed are those of the author and do not necessarily reflect those of AMP. These views are subject to change depending on market conditions and other factors.