Introduction to Emerging Market Trends 2019
The US financial crisis of 2012 had its repercussions across the globe and Europe was also not immune to recessionary trends in the past eight years. However, the emerging market led by China, India, Brazil, and Russia had a fairly good growth rate and was an exception to the general global trends having reached near double-digit growth rates at one point in time.
After the US crisis of 2010, it was the emerging market of Brazil, India, and China that saved the world markets from total disaster.
Globally recessionary trends, subprime lending activity in the Asian region especially China fuelled by the real estate boom, finally began to peter out in the past few years. China’s Government had to undertake stimulatory measures to keep the economy from sliding further and at other times had to take drastic measures to curb overheating of the economy.
The year 2015 was volatile for investments in the emerging market but there is no optimism on the part of the industry and financial experts on the outlook for 2016. The fall in crude oil prices, weak stock markets, and a possible US interest rate hike are all having an impact on the market sentiments, analysts said.
The International Monetary Fund (IMF) has noted that global economic activity in 2015 remained subdued. The emerging market and developing economies accounted for 70% of the global growth but declined for the fifth consecutive year, despite modest economic growth in advanced countries.
The World Bank has forecasted $47 per barrel for crude oil in 2019 down from $61 in its October 2018 projections. Among the reasons for the fall in crude oil prices are weak growth prospects in major emerging market economies, apart from the likely resumption of exports by Iran, greater resilience in US production, and efficiency gains.
Lower crude oil prices may be good news for net importers while it is shocking for exporters of energy. For net importers of energy, currency devaluation and reduced capital inflows may take away the advantages of lower crude oil prices while commodity-exporting nations would have to balance public expenditures in tune with falling prices. This has to be done through better net commodity export realizations amid lower fiscal revenues.
Outlook not rosy for emerging market
IMF has noted that global trends will be influenced by three factors- 1) slowdown and rebalancing in China’s economy with focus turning away from investment, manufacturing to consumption and services, 2) lower commodity and crude oil prices 3)tightening of US monetary policy in view of resilient growth seen.
World Bank has noted that falling crude oil and commodity prices would remain the dominant theme in 2016. John Baffles, senior economist and author of Commodities Markets Outlook of World Bank, noted that commodity prices have the potential to rise slightly over the next two years. Oil prices which fell 67% in 2018 will fall by another 37% in 2019, a World Bank report noted.
The commodity demand growth in the past 15 years was led by emerging markets and weak growth in those economies does not augur well for most commodities. A further slowdown could reduce trading partner growth and global commodity demand. The emerging market scenario is causing reduced demand across commodities. Non-energy prices may decline by 3.7%, metals a whopping 10% after seeing a sharp decline of 21% in 2015, and agriculture is projected to decline by 1.4% in 2016. The decline in prices is caused by a supply-demand mismatch due to the comfortable level of stocks, lower energy costs, and plateauing demand for biofuel.
Positive factors for emerging markets
Following are the positive factors:
1. Positive Growth despite the gloom
After a steep fall to 4% economic growth, emerging markets may witness a 4.3 to 4.5% growth in 2016 which is much above the 2.2% growth expected in advanced economies, analysts at IMF point out. The lower commodity prices may favor net importing nations while exports face a tough time and how it evens out ultimately in the region will decide the quantum of growth in these markets.
2. Forex Bounty
Huge foreign exchange reserves provide a cushioning effect for emerging markets in times of crisis. It is estimated that forex reserves in emerging markets are at the US $8.4 trillion compared to US$ 5.2 trillion in developed markets overall. The balance of payments position in emerging nations is better than in developed nations. China is expected to deliver a current account surplus of over $550 bn in 2019 while Russia will have over $96 bn but India and Brazil have current account deficits which may be ironed out over time.
3. Favorable resources and demographics
Emerging markets have a huge young population, accounting for four-fifths of the world’s total, and three-fourths of the world’s land mass. They are large producers of hard and soft commodities. They have a large army of labor and account for considerable consumer spending due to increased disposable incomes.
4. Emerging markets will drive growth
Despite the recent fall in growth and market valuation in stocks, emerging markets are expected to grow two to three times faster than developed economies. US companies have performed well in 2018 on the back of their better returns in non-US markets, a Forbes analysis revealed. Compared to investors in stocks, public investors looking at ETFs (Exchange Traded Funds) seeking larger exposure to the region investing in indexes would find it more attractive to invest in EM. The ETFs have a large number of countries in the portfolio index and hence diversify risk.
Emerging market investment trends
The macro-economic picture for emerging markets (EM) is not that rosy and therefore that would impact investments in the region both in commodities and stocks. The year 2018 was a disappointment for investors in the region and the worst since the Great Financial Crisis. The iShares MSCI Emerging Market ETF (NYSEARCA:EEM) lost close to 15% value by the end of last year. This followed the recessionary trends in Russia and Brazil due to falling commodity prices.
- Lower returns on corporate debt and bonds:
J P Morgan has estimated EM government and corporate debt to be as little as 1-3 percent. Returns on local currency debt could be 3.7% if external factors improve. In 2016, investors will demand higher compensation for the risk of holding EM debt over safe-haven assets due to weak growth, according to JP Morgan. Concerns about over-indebtedness and likely increases in default rates by EM nations could act as dampeners. The EM high yield corporate default rate is expected to rise to 3.5% in 2016, from 2.9% in 2015.
JP Morgan expects its sovereign bonds index to climb to 425 basis points up 40 over US Treasuries. A basis point is one-hundredth of a percentage point. In EM Corporate debt, Asia is preferred over EMEA or Latin America.
- Stock markets in EM are risky despite low valuation:
Some experts opine that despite the lower valuation of stocks in EM, it is not perhaps the right time to accumulate stocks.
According to Gary Ribe, Chief Investment Officer of the financial advisory, Macro Consulting Group, the valuation gap is not big enough to advise more investment in EM stocks. Assets in high-risk, high-growth sectors are cheap after a dismal performance in the past few years.
Better returns and stock valuations would be dependent on the movement of commodity prices upward and hence asset managers aren’t keen to increase exposure to EM. China’s deceleration is quoted as a major reason for the hesitant attitude of fund managers. China at one point in time had achieved a double-digit annual growth rate but is not languishing at 6.5% leading to falling in the EM growth rate to 4%.
IMF noted that the faster-than-expected slowdown in imports and exports due to weaker investment and manufacturing activity in China is having spillovers to other economies through trade channels and weaker commodity prices, as well as through diminishing confidence and increasing volatility in financial markets. The dramatic declines in import-export activity in EM nations in distress are weighing heavily on global trade, IMF noted.
According to Lazard Asset Management, extreme caution has to be taken in terms of portfolio positioning and ensuring balanced cyclical exposure to stocks in 2019. Last year, energy and materials stocks fell 17% and 23%, while health care and consumer staples gave a better performance declining only 5% and 9% respectively.
If greed ruled the markets between 1999 and 2007, the current environment is fueled by fear. The low relative valuations are compelling for long-term investors. However, the market will look for improved corporate profitability, currency, and commodity prices to stabilize. Much would depend on the pace of government and corporate reforms, according to Lazard.
Lazard pointed out that they are looking for companies that are opportunistic and resilient, including those that are taking market share from weakened competitors and showing innovation and strong capital discipline. However, investors as well as fund managers need to be selective in their investment behavior.
According to Vlad Signorelli, Brettonwoods Research LLC, investors should look for countries with lower levels of taxation on capital alongside a policy of gradual currency appreciation. Predictable tax rates and appreciating currency is a powerful allies in the fight against inflation, a scourge in EM.
Market risks and political response
The growth of 4.3 to 4.5% would happen provided there are no downside political risks emanating in different countries of EM. The ongoing crisis requires adequate governmental intervention – for eg. rubber prices are at the lowest in the past decade and it is related to lower energy prices, recessionary trends in the economy, and increased supplies. Agri-commodities, industrial commodities, and energy require different levels of intervention to tide over the crisis.
IMF sees the need for policymakers to manage vulnerabilities and rebuild resistance against potential shocks while staying focused on growth. Allowing for exchange rate flexibility is important for cushioning the economies from external shocks. This applies more to commodity exporters who are vulnerable to exchange rate variations. Policymakers irrespective of markets, have to pursue structural reforms to alleviate infrastructure bottlenecks, facilitate a dynamic and innovation-friendly business environment and bolster human capital. IMF notes that providing depth to local capital markets, improvising fiscal balances, and diversifying exports away from commodities have to be done.
There will be variations across EM in economic growth with China expected to grow at 7.3%, while Latin American and Caribbean economies may contract albeit at a smaller rate compared to 2018. Positive trends could emerge in Emerging Europe, sub-Saharan Africa, and the Middle East although lower commodity prices, geopolitical tensions, and domestic strife weigh on economic growth in these regions.
Emerging markets have tended to be a mixed bag witnessing deceleration in growth in the past few years but still ranking above-developed nations. The focus would be on the US economy, China, BRICS, and developments in Eurozone. The US Federal Reserve continues to actively monitor the global economic and financial developments and kept its rates unchanged on Wednesday. The Fed is believed to raise rates this year, but due to financial and economic turmoil, it was expected to maintain a loose monetary policy.
With crude oil prices plummeting to $27 a barrel, the lowest since 2003, global stock markets from London to New York have plunged.
Amidst all the gloom and doom for the global economy, emerging markets appear to be resilient although they appear to be stressed due to falling commodity prices, weakening currencies, and lower corporate profits.
Many experts feel 2009 may turn out to be worse than 2010 when the US economy went into a financial crisis following the housing crisis of 2007. Billionaire investor George Soros has warned that the situation is terrible with China facing a struggle to adjust from an export-driven economy to one reliant on domestic consumption.
The increase in US Fed rates would have implications for borrowers and the strengthening dollar is only adding to their woes. Following the near-zero interest rates prevailing in the US after the 2010 crisis, many emerging market companies, banks and governments had taken dollar-denominated loans. Now, these debts are more expensive to pay back at higher interest rates adding to their misery.
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