|Summary: Emerging markets have been skittish of late, amid general fears events in the US such as the scaling back of the Fed’s stimulus program will affect global capital flows. But in reality, individual countries within the “emerging markets” pack are in a strong economic position – in some cases, stronger than the US and other developed countries. The emerging markets panic is overdone.|
|Key take-out: If you have the risk appetite and the time frame, it would probably be a good time to buy emerging markets. Also, start by buying the developed market dips.|
|Key beneficiaries: General investors. Category: Economics and investment strategy.|
Who would have thought 2014 would begin with an emerging market panic?
Concerns over emerging market economies are not new. We saw fears arise last year in response to the ‘taper tantrum’ (reaction to the US Federal Reserve’s decision to start winding back its money printing program), and global institutions and newspapers have been doing a pretty good job in drumming up concerns.
The International Monetary Fund did so only a week ago. The key issue, according to this consensus, is how the Fed taper will affect capital global capital flows. The theory is that the emerging markets saw a huge influx of funds as the Fed cranked up the printing presses and global investors sought higher yields elsewhere. With the Fed now tapering, the fear is we will see the reverse.
The story to date isn’t so bad. At this point, the emerging market rout is only really a currency rout. Equities have been largely spared and there is no evidence of the panic that hit some currencies. That’s not to say emerging market stocks have done well. They haven’t, as you can see in chart 1 below – but it’s not a rout and it’s really no different to what we’ve seen in past years. It’s same old.
In addition to that, it’s not like anyone is talking about a collapse in actual economic growth or anything; even the IMF, which has been beating the emerging market crisis drum quite loudly. Take a look at these forecasts from the IMF. Growth is expected to remain good.
All we have seen so far is a huge currency depreciation of some 12-20% or so for countries like Turkey and Argentina. Again though, it hasn’t been broad based. In countries like Russia and Brazil, exchange rate depreciation has been modest – 1-3% this year. In truth it’s probably not accurate to even call it an emerging market crisis at all (not that the emerging markets should be treated as one market at all – they are a disparate bunch).
Taking a broader look at things, many emerging market nations have seen a sizable depreciation against the US dollar for years – especially since 2011. But this hasn’t necessarily got anything to do with concerns over any one nation as such, or even the Fed’s taper. Recall what we were seeing in 2010 and 2011. The market meme then was that the Euro zone was at risk of implosion and breaking up, and every other day eminent professors of economics were forecasting a US double-dip recession. Where else were investors going to go? In many ways the depreciating emerging market currencies since reflects a correction from the excessive and misplaced pessimism towards Europe and the US – overlayed , more recently, with specific problems to individual countries rather than emerging markets as an entire investment destination.
Noting that backdrop, we have to beware of the European experience. You know the contagion story – trouble in Greece flowed, wrongly, through to countries like Italy and Spain. But as I argued at the time, Italy and Spain didn’t actually have a debt crisis. It was the market panic that caused problems for Spain and Italy -liquidity dried up. The message: the same thing could happen for the ‘emerging markets’.
But how likely is it? Well, there is certainly no reason why it should. I’m not sure that there are pragmatic reasons why capital flows would unwind in the first place. That is, it wouldn’t be rational at least.
Consider the charts 3 to 5 below. The first shows budget deficits (government spending less revenues) as a percentage of GDP for select emerging market economies, the US, Britain and Japan. Chart 3 shows that some of the problem economies like Argentina and Russia – even Brazil and India – have much better fiscal positions than Japan, the US and UK. That is, their governments are much more disciplined with the exception of maybe India, although the deficit here is still not as bad as the UK’s or Japan’s.
You can also see that in chart 4. Public debt (or government debt) to GDP reflects the cumulative build-up of budget deficits over time. There simply is no comparison. The public debt situation of the three developed economies – especially Japan – is dramatically worse than the major emerging economies – even those at the epicentre of this latest flare-up. Public debt (as a ratio of GDP) in the US and UK at around 80-90% of GDP is two to four times the public debt held by the larger emerging nations. For Japan that’s more like four to 10 times worse. The fact is, public debt held by these large emerging nations is very low compared to the developed economies.
On the external accounts, the story looks a bit more mixed. Turkey and India both have sizeable current account deficits – but then, so does the UK (the current account shows net transactions for trade and income flows such as exports, imports, interest and dividend payments in aggregate that a country makes). Moreover, countries like Argentina, Russia and Brazil are in a much better situation.
Chart 6 shows foreign debt to GDP. It represents the cumulative effect of running a persistent current account deficit over time. This is because countries have to raise funds or borrow money for any current account deficit they run. How much they have borrowed, and the capacity to repay it, is recaptured by the foreign debt to GDP ratio. Again, the charts shows that investors have nothing to worry about with larger emerging market countries. Foreign debt is low. Note that in the above charts I didn’t include China – the only reason is that I have done that elsewhere and China has one of the best balance sheets in the world. Very low debt with no signs of problems brewing – despite all the subterfuge you hear.
There is no rational reason why the ‘emerging markets’ should be a problem. Their metrics are much better, in many cases, than the US, UK and Japan, which is probably why central banks in those three nations need to print money.
Who else would want to buy their bonds? I certainly wouldn’t and I don’t suggest any retail investor does either. Ironically, those very nations are the key beneficiaries when you see these market jitters. The Fed, in particular, is probably quietly very pleased about the fortuitous timing of this latest emerging market flare-up – to coincide with its latest taper. US bond yields actually fell on the Fed’s decision! Safe haven flows etc.
With all of that in mind, I would play any increase in market anxiety over emerging markets the exact same way I suggested we play Europe. Buy the dips. Timing is everything though; don’t needlessly swim against the tide, but if panic does flare up wait for a lull, for things to wash out, then snap up some bargains.
As for investing in emerging markets? I remain a long-term bull. What we are seeing now is based on nothing, and long-term fundamentals will reassert. If you have the risk appetite and the time frame, it would probably be a good time to buy emerging markets.
You may have to wait some time for gains though. Otherwise, there is probably a little too much risk for other investors – so I would keep to the sidelines at this point. Start by buying the developed market dips.